Economic uncertainty? Definitely!
Wow! It feels like we made it through the worst of COVID-19 and all the disruptions. Work from home, shop from home, kids at home — staying home became the “new normal” for a lot of us, while everyone else remained in the workplace under very different conditions. As we turn the corner, things feel more like the “old” normal. The U.S. economy went from a run to a crawl to a sprint in a span of 16 months.
We often ask where things are going. When’s the last time the news media got excited talking about lumber? And with good reason: Lumber reached an all-time high in early May at $1,711/1,000 board feet and then retreated back to $967 in less than two weeks. While readers of this article may be more interested in dairy products, it’s hard to get away from everything happening in the economy today. Many commodities are part of this discussion. To put into additional perspective, May data showed core U.S. inflation at its highest level in nearly 30 years. Inflation has been real; the question is, to what extent?
Understanding inflation
Recently, transitory versus permanent inflation has become a topic of discussion. While the markets and yield curve seem to signal transitory, the jury is still out. For those involved in the commodity chain, there have been massive moves up and down. For some that has meant opportunity; for others that has created challenges. Inflation can easily be explained by supply and demand. We hear stories about cargo ships stacked up in Chinese ports, as well as domestic ports like Long Beach. There’s a backlog of goods and a lot of key items missing in the supply chain. In the latest jobs report released by the U.S. Bureau of Labor Statistics on June 8, the number of job openings reached a series high of 9.3 million on the last business day of April. There can be a real cost to finding employees and having to pay fewer workers more money to come to work. Many factors add up to inflation. Time will tell when inflation unwinds and at what level things stabilize.
Observing interest rates
It’s hard to write an article about the economy without mentioning interest rates. The U.S. is in a steady environment of low rates — particularly short-term rates which are near zero. Inflation is certainly on the radar, but as of now the consensus among the Federal Reserve and the market seems to be a “wait and see” approach. The lower rates we’re seeing have certainly benefited homeowners who have refinanced, first time home buyers and those looking to tap equity in their home. In the commercial world, companies have been active utilizing cheap debt to grow and expand their businesses.
Should we get nervous when interest rates start to go up? Does home buying slow down, do businesses stop expanding, does car buying come to a halt? There could be an effect on those decisions with small incremental increases. However, even if rates drift up from here, they are still likely to remain “low,” in a historical context, for some time. Nevertheless, a rising rate environment could have a material impact on the servicing cost of U.S. government debt. The COVID pandemic spurred calls for massive government intervention — to date over $5 trillion dollars. This was a lifeline for some, and for others, an opportunity to build up a small savings account. While a social benefit, the long-term impact is that $5 trillion was added to an already mounting national deficit. It was estimated back in March that the interest cost on the national debt is just over $300 billion dollars per year, representing 9% of all federal revenue collected. Each 1% rise in interest rates could increase interest expense by roughly $225 billion at today’s debt levels. While the one-two punch of bigger deficits and higher rates may be sustainable in the short term, longer-term ramifications could be severe.
Seeking stability
There is some expectation of rate stability in the near term. The Federal Reserve Federal Open Market Committee held their most recent meeting June 15 and 16. There was no change in the Fed Funds target rate. The Dot Plot, a graph representing each member’s forecast for interest rate policy, changed from the prior meeting, with the expectation of two rate hikes in 2023. Prior to that meeting, hikes were not anticipated until 2024. Furthermore, seven of the 18 members see a hike as soon as next year. The impact was that the markets perceived the Fed as more hawkish, meaning more likely to pull back the punch bowl sooner than later. This resulted in a sharp rise in rates on the front end of the curve. However, rates drifted back down over the next few days as the market digested the information and likely acknowledged a lot of things can happen between now and then.
What does all of this mean? A lot to some, and business as usual to others. The takeaway is to understand how all these factors affect the business you’re in, and create your plan to deal with what comes next. Do low rates mean now might be a good time to refinance or expand? Does a lack of labor mean that you have to cut back production? Has the volatility in the commodity markets caused a need to create or revisit a risk management plan? Does the increase in consumer demand and the extra stimulus floating in the economy present an opportunity for your business? Being better informed and prepared for what is going on outside your business is just as important as the work that gets done inside. Take some time to plan and understand where your business is going, as well as challenges and opportunities on the horizon.
Ty Rohloff, a senior food and agribusiness lending relationship manager with Compeer Financial authored this piece as guest columnist for this week’s issue of Cheese Market News®.