Provided by: Jeffrey Holaday
Solid economic conditions in the U.S. persisted in Q1 2018 causing a noticeable rise in long term interest rates. U.S. GDP grew 2.2%, which is a solid reading considering Q1 growth rates have tended to be weak in recent years.1 These developments were overshadowed, though, by an increase in trade tensions between the U.S. and China. Both nations have since demonstrated a willingness to negotiate and we are optimistic an eventual settlement will be reached. Globally, economic conditions also remained strong and provided a favorable backdrop for strengthening agricultural product demand. In the latest World Economic Outlook,2 the International Monetary Fund (IMF) reaffirmed its outlook for a continued improvement in macroeconomic conditions, citing the upswing in advanced economies which began in mid-2016. The coordinated growth in economic activity bodes well for agricultural demand as rising incomes are closely tied to the consumption of protein and other high value foods.
Since September of 2017, the 10-year U.S. Treasury Note (10-yr) increased roughly 0.80%, raising concerns that higher long-term interest rates could weigh on farmland values. While this is certainly a concern, it is important to recognize that farmland valuations are subject to a myriad of factors that could offset the impact of higher interest rates. This is evident by simply examining history. Since 1924, the 10-yr increased 48 times (approximately half of the time), but farmland values were much more likely to rise than fall, increasing between 72% and 84% of the time depending on the region.3 While the likelihood of farmland values falling during this period was already low, the likelihood of a decline in farmland values coinciding with an increase in the 10-yr was extremely low, ranging from 5% to 9% of the time, depending on the region.4 Furthermore, farmland values were actually more likely to increase in value in the three years following a rise in interest rates.5 In our view, this suggests that other factors such as expectations for income growth and inflation influence farmland values to a greater degree than interest rates. We do not believe the outlook for income growth is as dire as the 7% decline in Net Farm Income projected by the USDA in February 2018. A recent publication by researchers at the University of Illinois reveals the USDA’s February forecast has historically had a conservative bias. In their revised forecast released in August, the USDA has raised their projection 68% of the time since 1975. In addition, downward revisions to their estimates have mainly occurred near the peaks in commodity price cycles and we believe we have reached a bottom. While it is possible Net Farm Income could decline again in 2018, the USDA’s February forecast has not been a reliable predictor. Finally, rising inflation expectations could mitigate the impact of higher interest rates. Farmland values and commodity prices have historically moved in sync with inflation.7 If this relationship holds, it is possible inflationary pressures could offset the impact of higher capital costs for the sector.
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Jeff Holaday| Senior Associate Director | MetLife Agricultural Finance P.O. Box 632265, Highlands Ranch, CO 80163-2265 | T. (303) 997-7750 | M. (720) 936-8362 | [email protected]