Farm Interest Rate Spreads Go To Extremes

Farm interest rates in 2023 and early 2024 reached the highest level since 2006 to 2008 (Figure 1). The upturn has prompted many observations and headlines. For instance, rates dramatically increased in just 18 months. Also, rates have arguably returned to levels close to the long-run normal.

We’ve argued that the general interest rate upturn has overshadowed other important shifts in lending, specifically the inverted yield curve. Often discussed as a predictor of a looming recession or slowdown, the inversion – which began nearly two years ago- has affected farm loans in two ways: 1) farm operating lines are relatively pricey, and 2) fixed interest rates are historically cheap.

Figure 1. Average Interest Rate on Ag Operating and Real Estate Loans, 1991Q1 to 2024Q1. Data Source: Kansas City Federal Reserve Bank and AEI.ag Calculations.

Interest Rate Spreads: Operating Lines Relatively Pricey

Since 1977, the average interest rate on farm operating loans has been 27 basis points less than that on farm machinery loans. Between 2013 and 2021, that spread has been even wider, with short-term operating loans running -50 to -100 basis points of spread compared to machinery loan rates (Figure 2).

In 2023, however, the spread abruptly shifted. Operating loans that year averaged +45 basis points of spread. During the first quarter of 2024, the spread shrank to +15 basis points but remains historically high.

Figure 2. Farm Interest Rate Spread: Operating Loans Less Machinery Loans. Data Source: Kansas City Federal Reserve Bank and AEI.ag Calculations.

 

Farm operating loan rates are also historically high relative to farm real estate loans (Figure 3). Since 1991, farm operating loans have been, on average, 45 basis points above real estate interest rates. Since 2023, the spread has been +70 to +80 basis points. Furthermore, the spread peaked during the second quarter of 2023 at +87 basis points, the highest observation in more than three decades of data.

The last time operating loans were historically pricey was between 2006 and 2007.

Figure 3. Farm Interest Rate Spread: Operating Loans Less Real Estate Loans. Data Source: Kansas City Federal Reserve Bank and AEI.ag Calculations.

 

Interest Rate Spreads: Fixed vs Variable Rates

The effects of the yield curve inversions are also visible in the spread between fixed and variable interest rates. Figure 4 plots the interest rate spread (fixed minus variable) for farm real estate loans. Unfortunately, these data are only available since the early 2000s, but current conditions are, again, at extremes.

Historically, fixed interest for farm real estate has been 37 basis points higher than variable rates. Between 2013 and 2015, the spread exceeded +50 basis points, and in the early 2000s, conditions were above +60 basis points.

The spread has trended lower in recent years, making the cost of fixed rates low relative to variable rates. In 2023 and 2024, the spread reached new lows and fell to -2 basis points in early 2024. This means that variable-rate farm real estate loans were higher than fixed-rate loans for the first time in 20 years of data.

Figure 4. Farm Interest Rate Spread: Fixed Real Estate Less Variable Real Estate. Data Source: Kansas City Federal Reserve Bank and AEI.ag Calculations.

Wrapping it Up

A few years ago, we warned that inflation causes problems in the economy because it messes up relative prices. Over the last 18 months, inflation and the Fed’s efforts to fight it have affected relative interest rates. Today, short-dated money, such as farm operating lines of credit, have been hardest hit by rising interest rates. Fixed-rate real estate loans have benefited.

It’s not uncommon for these relationships to move, but producers should keep these conditions in mind as they consider future borrowing. Those frustrated by the overall higher interest rate environment—and betting or hoping on lower rates soon—may lean towards short-term rates (such as operating loans) and variable rates. On the other hand, those expecting interest rates won’t change much from here – or may go higher – may find longer-term debt and fixed terms more attractive.

A big unknown is how the yield curve returns to normal or becomes un-inverted. One possibility is for short-term rates to fall, meaning long-term rates will slowly adjust downward. Another outcome could be for short-dated money to remain unchanged as long-term interest rates increase. This is all to say that the hopes of lower interest rates may come with limited relief for long-term interest rates.