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Historical Federal Reserve Rate Hike Cycles graph

Written by Krista Swanson

Inflation and interest rates are perhaps the top economic buzzwords of 2022. As we close out a year with seven interest rate hikes resulting in a federal funds target of 4.25% to 4.50%, it’s easy to forget that rate was around zero less than a year ago. Let’s dive into what is driving the decision to increase interest rates, how it impacts us, and the outlook for interest rates in 2023.

Rising Prices Erode Consumer Purchasing Power

Inflation is the rate of increase in prices over a given period of time. Although it has a bad reputation in 2022, inflation is a normal characteristic of a functioning economy. In fact, the target rate for inflation isn’t 0%, it’s 2%. The United States has managed to maintain an average inflation rate relatively close to that target for decades before reaching a forty-year high of 9.1% in 2022. At that point, a dollar could buy 9.1% fewer goods and services than it did a year prior. That’s a noticeable decline in the purchasing power for American consumers.

Rising Prices Warrants Fed Action

Prices rising too high and too quickly warrants action from the Federal Reserve (“Fed”). The Fed is an economic institution responsible for maintaining price stability and maximizing employment, per a dual mandate set by Congress. Plenty of other factors come into play, but simply put, it means the Fed usually raises rates when the economy is expanding at an unsustainable rate (high inflation) and usually cuts rates when the economy seems weak (high unemployment). In 2022, the combination of high inflation and a hot labor market with low unemployment made the need for raising rates clear.

The policymaking body of the Fed, the Federal Open Market Committee (FOMC), can achieve their goals by changing the federal funds rate – the rate at which commercial banks borrow and lend their excess reserves to each other. Changes in the federal funds rate often correlated to changes in the interest rates on consumer and business loans.

The Fed Raises Rates at the Fastest Pace Since 1980

Although inflation moved above 2% in March 2021 and continued to trend upward, the FOMC didn’t take action to increase the federal funds rate until March 2022. Given the slow evolution to take action and the very low starting point, the Fed has moved quite aggressively, raising rates at the fastest pace since 1980. In the four most recent rate hike cycles, rates were raised more slowly over a longer period of time to achieve the desired economic result.

Interest Rates Outlook for 2023 and Beyond

Based on the most recent FOMC assessments for future changes, it’s likely the federal funds rate will increase another 75 to 100 basis points in 2023. I would expect that to be heavily weighted in the first quarter of the year and then a pause in action in the second half of the year. A reduction in the federal funds rate isn’t expected to begin until 2024, with a slow-paced, gradual decline over a few years.

Interest Rate Considerations for Your Farm

Rising interest rates will have an impact on farms. Many farms have operating loans on a fixed one-year term or a revolving loan with a moving interest rate that may change each time the federal funds rate is changed. Higher operating interest cost is to be expected.

I would normally use extra working capital to make early payments on term debt with the highest interest rates. At this time any new machinery, building, or land purchases financed will likely have a higher rate than any term debt already on the books. I don’t want to pay down term debt early and turn around and finance a new purchase at a higher interest rate. Given this environment, a revised strategy is to use extra working capital for smaller capital purchases as long as it doesn’t compromise liquidity or try to push off capital purchases that aren’t necessary and build working capital needed for down payments and loan payments in the future.

These decisions will vary by farm given differing financial positions and goals. Accurate recordkeeping and a strong relationship with a farm accountant and agriculture lender who can advise are important, a wise New Year’s resolution for any farmer!

Historical Federal Reserve Rate Hike Cycles graph

Krista Swanson is a consultant and speaker for her business AgSCOPE, and a research analyst for the Department of Agriculture & Consumer Economics at the University of Illinois where her work is frequently published in articles on farmdoc. Krista and her husband actively farm with his family where they raise corn, soybeans, and four kids on the farm. 

Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the views, opinions or positions of FCS Financial.

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