The U.S. economy remains strong by many economic measures. Two-plus years of low
unemployment continue to drive year-over-year wage growth, while gains in the stock market
have increased the net worth of U.S. households. Consumers, in turn, are spending.
But that same good news for workers and households is bad news for a Federal Reserve intent
on taming inflation. The March Core Consumer Price Index (CPI), excluding food and energy,
was up 3.8%, well above the Fed’s 2% target. While markets still anticipate interest rate cuts in
2024, the Fed’s next steps remain unclear. It kept interest rates between 5.25% to 5.5% in
March.
Agricultural producers need to plan for the possibility that interest rates will remain higher
longer. Financial efficiency will be critical in the year ahead and we have some ratios to help you
focus on the right areas of your business.
Interest Rate Drivers
The U.S. unemployment rate is at 3.8%, with 1.36 job openings for every unemployed person.
Unemployment has now been under 4% for the longest stretch since 1967, following the
Vietnam War and leading up to the 1970 recession.
The tight labor market has led to year-over-year wage growth of 4.1%, well above the average
wage growth of 2.5% prior to the COVID-19 pandemic.
The resulting inflation is a challenge for both the Federal Reserve and U.S. consumers. The
March CPI for all items was 3.5%, up from 3.2% in February. The U.S. has now reported 28
consecutive months of core services above the Fed’s 2% target, as shown in Figure 1.
More concerning for the Fed is the sticky-price CPI, so-called because prices on included goods
and services change less frequently. This CPI, which excludes food, energy, and shelter, stands
at more than 3.1% year-over-year, the highest since July 2023. The sticky-price CPI is thought
to incorporate expectations about future inflation to a greater degree than prices that change on
a more frequent basis.
Stress Signs for U.S. Consumer
The U.S. consumer has proven resilient in the face of inflation and higher interest rates,
largely due to wage growth, long-term debt locked at record low interest rates,
government stimuli during the pandemic and student loan forgiveness. However, stress
signs are emerging, including in the areas of disposable income and debt.
In 2023, monthly
year-over-year
growth in per
capita, inflation-adjusted
disposable
incomes averaged
a robust 3.7%. For
context, the pre-pandemic
average
was 1.6%.
While still positive
year over year,
wage growth is
weaker. Per capita
real disposable
income in February
2024 was 1.1% higher than in February 2023, but 0.1% lower than in January 2024.
The pace of wage growth has slowly subsided since March 2022 and higher inflation is
weighing more heavily on consumers.
Credit card debt is piling up, reaching roughly $1.13 trillion. This is a record on a nominal basis,
and when adjusted for inflation only 9.5% lower than the time-series high in late 2008, Figure 2.
The steep increase in credit card debt since 2022 is worth monitoring, as is consumers’ ability to
manage their minimum required payments and the high cost of carry.
The New York Federal Reserve’s monthly Survey of Consumer Expectations found consumers
increasingly concerned about making minimum debt payments during the next three months.
The highest share of
concerned consumers
was 40 and younger,
but those between the
ages of 40 and 60,
Figure 3, showed the
sharpest increase.
This is significant
because the middleaged
cohort has a low
unemployment rate
compared to the
overall national
average.
For now, U.S.
households are
managing debt.
Household debt
service payments as a
percentage of disposable income was low, 9.8%, at the close of 2023. Since 1981, household
debt service payments as a percentage of disposable income averaged 11.8% at the start of
every recession.
Consumers also are saving far less than normal, 3.6% compared to the 10-year, pre-pandemic
average of 6.2%. While the U.S. economy remains strong, cracks are slowly showing.
Government Debt and Interest Rates
The U.S. consumer has benefitted from government stimulus programs, student loan
forgiveness and other actions that, to date, have served as a buffer to the Federal Reserve’s
restrictive monetary policy. It also carries a cost. The U.S. government is expected to run trilliondollar
deficits out to 2034.
That is concerning enough. But there also is the risk of upward pressure on interest rates if the
supply of Treasury securities continues to grow.
When Treasury rates rise, investors tend to prefer low-risk government bonds to riskier
investments. To compete for bond investors, businesses must offer higher rates, leaving less
money for capital reinvesting.
Financial Conditions and the Stock Market
In March, the Federal Reserve released a Quarterly Summary of Economic Projections that
included an expectation for lower real GDP in 2024, inflationary pressure until 2026 and an
unemployment rate hovering near 4%.
It also appeared the Fed would stay the course and based on its December projection,
potentially cut the federal funds rate three times in 2024, each the equivalent of 25 basis points.
That looks less likely in recent weeks, with stronger-than-expected inflation and economic data.
Market expectations
have not aligned with
Fed signals. At the
start of the year,
investors anticipated
six, 25-basis point
equivalent rate cuts in
2024. As of April 17,
2024, market
expectations dropped
to one cut. The shift in
market expectations is
shown in Figure 4.
The resilient and
robust economic
outlook played a factor
in the recent stock
market rally. The S&P
500 has increased roughly 11% since the start of 2024 and 23% from the first quarter of 2023 to
the first quarter of 2024. Combined growth in the S&P and wages increased the net worth of
households by 9.2% between Q3 2022 and Q4 2023.
Lending Standards
As the Federal Reserve
raised interest rates,
beginning in 2022,
banks tightened lending
standards, including
requiring more
collateral and stronger
credit standing to
qualify for a loan.
Figure 5 shows the
growing share of banks
that tightened
standards on
commercial and
industrial loans.
The Federal Reserve’s
rate hikes also had their
intended purpose of
lowering inflation. So far, the Fed’s tight monetary policy hasn’t tipped the U.S. economy into
recession. Markets were optimistic that the Fed would cut rates in 2024, possibly as early as the
first quarter. This optimism always was out of step with Fed statements.
In an environment of easing interest rates, banks generally expect increased credit demand. A
January survey from the Federal Reserve showed a decline in the share of banks tightening
lending standards for commercial and industrial loans to large and middle-market firms. The
share fell from about 34% to 14.5% (Figure 5) in the last half of 2023, despite the Fed
maintaining rates and the federal funds effective rate at its highest level in more than two
decades. In fact, the share of banks with tighter standards was lower in Q4 2023 than most of
2022, when the Federal Reserve started hiking rates from record-low levels.
The expectation of rate
cuts and the resilient
economy factored into
the stock market rally
this year. As Figure 6
shows, there has been
a relatively moderate,
inverse relationship
between the share of
domestic banks
tightening lending
standards and the
performance of the S&P
500. It is important to
note that the axis for the
S&P 500 is inverted
meaning a decline in the
blue line shows positive
year-over-year growth.
The expectation of rate cuts also tends to drive demand for credit from consumers and
businesses looking to expand. Conversely, when lending standards tighten, there is a tendency
for the market valuation of the S&P 500 to decrease. Investors grow concerned in a rising rate
environment that the Federal Reserve’s actions could slow economic growth to the point of
recession.
The reality today is the economy still hasn’t fully digested the current rate environment.
Economic data from the first quarter of 2024 pointed out that the Federal Reserve hasn’t
accomplished its goal of controlling inflation.
The result: Markets likely will be more volatile and economic conditions tighter than predicted at
the start of 2024.
What This Means for Agricultural Producers
All the talk about rate cuts is premature. The market and economy will tell the Federal Reserve
when to adjust policy, not the other way around. This means the market must navigate the
current rate environment.
Producers should build scenarios that account for no rate cut up to three cuts of 25 basis points
each. However, based on today’s economic data, focus on the impact of fewer to no rate cuts in
2024.
Today’s prime rate is 8.5%. Three rate cuts equivalent to 75 basis points would put prime
between 7.5% and 7.75%, assuming the 30-year average spread between the fed funds rate
and prime holds. If rates are kept higher for longer, interest rate savings will be nominal in 2024.
In this environment, producers need to focus on financial efficiencies for their operations. It is
unlikely that significant costs savings will occur through lower interest rates this year, so it is
important for producers to generate revenue while controlling costs.
Below are three financial efficiency ratios for producers to consider.
The first ratio to benchmark is the operation’s interest expense ratio:
(Interest Expense/Gross Farm Revenue) x 100
The interest expense ratio shows how much gross farm income is used to pay for borrowed
capital. The lower the interest expense ratio the less reliant a farm is on borrowed capital and
the lower its cost of debt. A ratio of less than 10% is desirable; 10% and 16% is stable; and the
ratio is at higher risk above 16%. If your operation’s ratio is at higher risk, look for ways to
reduce borrowed capital.
Next, know your operation’s expense ratio:
((Operating Expense – Depreciation – Interest)/Gross Farm Revenue) x 100
This ratio shows the proportion of farm income used to pay operating expenses, not including
principal or interest. The lower the ratio the more efficient the farm is at utilizing inputs during
production. A desirable ratio is less than 65% and 65% to 80% is stable. Above 80% may be
considered higher risk, indicating a farm is overleveraged with operating expenses.
Finally, with commodity prices declining faster than many input costs, producers need to track
how efficiently they are using all their inputs during the production year. The net farm income
from operations ratio is a good benchmark:
((Net Farm Income from Operations/Gross Farm Revenue) x 100
This ratio shows how much income is left after all farm expenses are paid. A higher ratio
suggests efficiency. Aim for a ratio greater than 15%.
While each operation is different and contains a different commodity mix, these ratios serve as
recommended benchmarks. Producers should utilize these ratios and recommendations as
planning insights with the goal of staying ahead of potential financial challenges.
