Smart farmers are now working to prepare for a possible interest rate squeeze, says a leading U.S. agricultural economist.
According to a Canadian banker, Canadian farmers have been able to take such measures with less pain than their U.S. counterparts thanks to the falling loonie, which has eased the pressure felt by thousands of farmers south of the border.
“For the most part, Canadian farmers have had pretty average returns. It’s been business as usual,” James Fehr, vice-president of agriculture and agribusiness for the Royal Bank of Canada in eastern Manitoba, said in an interview.
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“There’s been the exchange (rate difference) that has really protected them from the downside.”
David Kohl of Virginia Tech, an adviser to Canadian farmers for 30 years, told farmers at the Dec. 7 Manitoba Dairy Conference that they can’t count on the low interest rate era continuing long into the Donald Trump presidency if he achieves what he wants.
“I’m watching really closely the first year of the Trump administration,” said Kohl in an interview.
Trump’s “pro-growth and less-regulatory” approach could lead to “more inflation, and when you have more inflation you’re going to have higher interest rates.”
If Canadian and world economic conditions “normalize,” young farmers will be dealing with something they might have never experienced. During the years of the commodity bull market, returns were high. During the low-interest-rate era, debt costs were low.
An inflationary period will make debt more expensive to manage and a more normal commodity period will continue to leave margins thin.
“During the super cycle, you could … make money because the economics were good. Now, whether you’re big or small, you also have to sweat the small stuff,” said Kohl.
As a farmer recently quipped to him, “big and sloppy doesn’t cut it any more.”
Kohl said good farm managers have been adjusting their businesses to deal with a prolonged period of narrow margins, keeping a close watch on cash flow, cost of production and budgeting.
He urged farmers to build good relationships with their lenders because keeping the debt situation well-managed will be key if interest rate volatility erupts.
Kohl said his own family’s dairy processing business recently locked in some interest rates on its debt because of the risk of interest rate increases.
Fehr said he has been encouraging farmers to consider locking in some rates too. Above all, farmers need to understand how their finances would be affected by interest rates rising one or two percent.
“That’s one of the things we talk to him about: cash flow and checking his cash flow against a sensitivity analysis for interest rates,” said Fehr.
Kohl said he thinks about 25 percent of young farmers will quit the business “in a New York minute” if a tight financial squeeze occurs. Twenty-five will struggle and 50 percent will “hunker down” and be able to ride it out.
Young farmers might not have faced a higher interest rate environment connected to a period of low returns, but they are generally well-educated and well-prepared, Kohl said.
“We’re watching the young producers to see if they can take an economic punch.”
Kohl is guessing that most of them can.
