The News & What it Means – Interest Rate Cuts Bring Both Good and Bad

By John DePutter & Dave Milne – March 17, 2020
The News:

“The Bank of Canada made a surprise interest rate cut on Friday, trimming its key overnight lending rate by another half point.”

Syngenta Market News, March 16, 2020
What it means:

For farmers, there’s a lot to like about lower interest rates. But the circumstances of this particular cut are anything but reassuring.

Let’s start with the good news. Lower interest rates obviously mean it’s less expensive for farmers to carry debt, and, at a time of increasing obligations and shrinking margins, anything that trims operating costs is positive. The numbers for 2019 are not in yet, but remember that, in 2018, nationwide cumulative farm debt increased 8%, to over $106 billion. Meanwhile, 2018 debt interest expenses soared almost 20%, the largest percentage increase since 1981.

Farm debt likely took another step up in 2019 and will probably continue to rise in 2020, so the Bank of Canada’s current key overnight lending rate of 0.75% is a help. For context, the Bank’s rate dipped as low as 0.25% during the worst of the 2008 financial crisis. We’re not that low yet, but with another rate announcement coming in April, we could get closer or match. It’s worth noting that, with its emergency cut this past weekend, the US Federal Reserve has already slashed its key rate to near 0%.

Another benefit of lower interest rates is generally a weaker Canadian dollar. And, as all farmers know, a lower Canadian dollar versus the US greenback supports local basis levels and farmer returns for those products sold on the international market in American dollars. As the chart below shows, the loonie has taken a heavy beating over the past number of weeks and is now trading at a four-year low.

Canadian dollar

In southwestern Ontario, the struggling loonie is translating to a strong elevator spot basis of about $1.55 over the May futures contract, keeping corn prices not far below the $5/bu mark. For soybeans, the spot basis at most elevators is $3.10 over May or over $11.25/bu.

When a central bank is forced to cut interest rates it’s usually not a good thing in terms of the economy, and this was no exception. Amid the spread of the coronavirus, everything from small businesses to professional sports leagues both here and south of the border are being forced to shut down, raising the spectre of a deep recession. The fact that the Bank of Canada slashed rates twice in two weeks simply underlines just how serious the impact may be.

Stock markets are melting down, pulling commodities down with them amid questions about demand. Of course, people will still need to eat. That fact alone should put a floor under crop prices, which have held up relatively better. But it’s fair to say that we are in unchartered waters. It’s impossible to know how farm profits will ultimately be affected.

Another downside of lower interest rates is the temptation to load up on debt. There’s plenty of examples of good debt and bad debt and, depending on how the lower rates last after the coronavirus crisis passes, it’s possible the amount of bad debt will start to pile up again, potentially setting the stage for another financial crisis down the road.

Farm and financial markets are becoming increasingly intertwined. Keep up to date with our monthly Interest Rate Alert report…

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