How Will Rising Interest Rates and Fluctuating Exchange Rates Affect U.S. Agriculture

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1 How Will Rising Interest Rates and Fluctuating Exchange Rates Affect U.S. Agriculture Jason Henderson, PhD Associate Dean and Director of Purdue Extension January 11, 2018

2 How Do Interest Rates and Exchange Rates Affect Agriculture? Higher rates lead to increased debt service Higher rates lead to lower asset values farmland Higher rates relative to other countries tend to raise US value of the dollar Higher value of the dollar limits US competitiveness in global markets

3 Farmers Face Higher Debt Service in 2019 U.S. Farm Interest Expenses (Three-year moving average) Billions of dollars (nominal) % since During this time, farm debt rose 18.6% Average Effective Interest Rates on All Farm Loans at Commercial Banks 2013: 4.1% 2018 (Q1 to Q3): 4.8% 0 Source: USDA Source: Agricultural Finance Databook

4 Higher Rates Place Downward Pressure on Land Prices Net Present Value : Net Returns (Cash Rents)/Interest Rate Interest Rate 3.0% 3.5% 4.0% 4.5% 5.0% $200 6,667 5,714 5,000 4,444 4,000 Cash Rent $250 8,333 7,143 6,250 5,556 5,000 $300 10,000 8,571 7,500 6,667 6,000 $350 11,667 10,000 8,750 7,778 7,000 $400 13,333 11,429 10,000 8,889 8,000

5 Is this a 1980s Scenario? Earnings Multiples on 10-Year Treasury, Iowa Farmland, and U.S. Stocks Farmland multiples greater than stocks and bonds Farmland multiples between than stocks and bonds Inverse of 10-yr Treasury Stocks P/E Ratio Iowa Farmland P/E Ratio Calculations based on data from CARD, Iowa State University and FRED, Federal Reserve Bank of St. Louis.

6 How High will Interest Rates Rise? 6.0 FOMC Fed Funds Rate Projections Percent Mar-18 Oct-18 Dec Longer Run Source: Federal Reserve Board of Governors

7 How Will Global Economic Growth Evolve? World Economic Output Annual Percent Change Area Oct. 2017F 2018 Oct. 2018F 2019 Oct. 2018F World Advanced US Euro Area EMDE China India Russia Latin Am Euro Area expectations fade April 2018 forecast 2.4% October 2018 forecast 2.0% Brexit and Government Debt 2018 Latin American expectations erode April 2018 forecast 2.2% October 2018 forecast 1.4% Brazil 2018 India rebounds as expected Source: International Monetary Fund

8 How Will Global Economic Growth Evolve? World Economic Output Annual Percent Change Area Oct. 2017F 2018 Oct. 2018F 2019 Oct. 2018F World Advanced US Euro Area EMDE China India Russia Latin Am In 2018, U.S. growth accelerated, but in 2019 it s all about trade IMF estimates that trade disputes trim at least 0.2% off US GDP in 2019 aproximately 1.0% of China GDP in 2019 Source: International Monetary Fund

9 What is the Fed watching? Labor Markets There are 7 million unfilled jobs in the US Wages are up 3.3% this year

10 What is the Fed watching? Inflation Where is Inflation Emerging? Inflation Expectations have Fallen Recently Home Price Index Earnings

11 U.S. Interest Rates Relative to Foreign Rates are Important Higher US rates are attractive to investors. International money flows to the U.S. 10 Year Government Bond Yields U.S. Dollar rises as investor demand grows. U.K. Germany Strong Dollar limits Agricultural Trade Japan

12 Interest Rates, Exchange Rates, and International Money Flows Money flows to highest rate of return. Higher U.S. interest rates attract money and boost dollar demand and exchange rates. US Trade-Weighted Dollar Index - Real 2000 U.S. Net International Investment Position (Asset Minus Liabilities) Billions of 2016 Dollars 0 Stronger Dollar Assets: US purchases Liabilities: Foreign purchases Source: U.S. Bureau of Economic Analysis :Q2 Money flows to the US

13 The Dollar Strengthens with Geopolitical Risks Geopolitical risks are increasing around the world. North Korea South China Sea Brexit Afghanistan Migrant Caravan Venezuela Turkey and Saudi Arabia US Election Israel and Gaza Middle East

14 Tomorrow s economic battle is over productivity. US Potential GDP (Average Annual Growth) Potential GDP Economic Potential Shrinks from 3% to 2% Potential Labor Force Potential Labor Force Productivity Need Higher Productivity to Offset Slower Labor Force Growth Source: Congressional Budget Office, The Budget and Economic Outlook April

15 Conclusion Farm downturns occur when interest rates and exchange rates rise. This time is not different. How will global economies evolve? Stronger growth higher interest rates Higher relative interest rates stronger dollar A lot of focus on trade policy and international money flows What will drive increased productivity in the US economy?

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