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Insight on Rise in Interest Rates

 

The other day I was conducting a family business seminar for Farm Credit Services Southwest and American Ag Credit. A number of the participants were keen on understanding some of the early signals for a possible interest rate rise. Interest rates have been at a historical low for a long period of time. Not within my greatest imagination would I have predicted this economic trend five or 10 years ago. So what should we look for in a possible rise in rates?

First, place a close watch on the Federal Reserve and their discussions being released about the economy. Focus on core inflation (not including food and energy), and headline inflation (including food and energy). Inflation rates are reported monthly by the Bureau of Labor Statistics. Ideally the Federal Reserve would like core inflation to be 2% and headline inflation to be 4%. A significant rise above 3% for core inflation and 5% for headline inflation would suggest the Federal Reserve will raise the Fed Funds rate.

Next, examine the reported unemployment rate. The current rate is 8.3%, down from 9%. If this rate drops to the range of 6-6.7%, this would be another sign of a possible rate rise by the Fed.

Third, if the U.S. federal debt is downgraded significantly by ratings agencies, foreign entities will demand a risk premium on debt. If the government pays higher interest costs, businesses will follow suit. Standard & Poor's and Moody's are the ratings agencies to watch.

One attendee noted that U.S. debt was downgraded last fall, but it did not result in an interest rate increase. That is correct because the Euro sector was experiencing problems, causing a flight of money to the U.S. as a safe haven, actually resulting in lower rates.

Focusing in on an individual business level, lenders will watch for trends in lower earned net worth, liquidity, equity or deterioration of the coverage ratio. If lenders see negative trends in these factors, your business’ interest rates may be increased due to the increased risk to your lender of financing your business.

 

Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.

TAGS: Management
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