January 2024 update

Interest rates

After spiking in November 2023 interest rates continued to follow bonds lower across the curve. The inverted yield curve reflects market sentiment that interest rates have peaked for this current cycle.

The differential between short-term and long-term rates is now at the lowest levels in four years and has moved negative.

In recent times borrowers held back from taking interest rate protection given the additional cost of locking in rates longer term vs the cheaper variable rates. Those that did generally locked in for 2-5 years, most of which have expired or are close to expiring. This has resulted in a significant portion of agricultural debt sitting on variable/short-term interest rates.

The relative value of longer-term rates now presents an opportunity for borrowers to fix rates long-term to decrease interest costs and reduce risk on a key business expense.

Note: Foundation Agri Finance price loans based on the current Australian Dollar Interest Swap Rate plus a customer margin. Please contact the team to discuss our competitive fixed-rate options.

What we’re hearing

November rain to the rescue – well-above average for most of northern and eastern Australia was a welcome reprieve for most after an exceptionally dry September-October. Livestock prices rebounded from multi-year lows and there is more optimism around summer cropping programs. Unfortunately, the excessive rainfall and flooding has negatively impacted many business.

Farm profitability is down – income levels have retreated after a few bumper years of high production and prices. When combined with increasing interest rates, this has seen farm profits decline. More income is now going to service farm debt and there is less available for investment purposes. We consistently hear that lending appetite is diminishing and approval timeframes increasing.

Property and water demand is mixed – the farmer-to-farmer market has retained its quiet demeanor whilst institutional investors demand continues. Fluctuating commodity prices and escalating funding costs remain headwinds driving some moderation in values particularly for secondary quality assets. The main market mover is water in the Murray Darling Basin after the recently announced government buy-backs. Back in 2009 the government set records by paying up to 40% premiums over the market to encourage sellers. The same inflationary approach is playing out with a recent tender for NSW Murray General Security Water selling for ~25% above market. It will be interesting to if see irrigators more broadly are active buyers of water entitlements given strong summer inflows setting up high allocations once again for the 2024/25 water year.

Macro view

United States: 

We have been firm believers for some time that the US Federal Reserve can afford and will want to leave rates on hold for quite some time.

In contrast the market is currently priced for 6 rate cuts (150bps total) in 2024. At the December Federal Open Market Committee meeting rates were left on hold at 5.25%-5.50% but the committee signaled potential 3 rate cuts (75bps total) in 2024. It is not yet clear that inflation in the US is under control and the Federal Reserve outlined four key risks to the outlook:

• Although the economy was resilient last year after multiple rate increases the natural lags in the economy may result in a contraction in business and consumer activity in the months ahead.
• Shelter and other services inflation remain higher than historical levels so this could mean that inflation remains above the US Federal Reserve 2% target longer than expected.
• Many businesses with pricing power may still increase prices more than expected.
• After 11 rate hikes the US economy remains surprisingly resilient with a strong labour market and consumer spending. The recent fresh high of the Dow Jones equity index is inconsistent with an economic contraction which would deliver the targeted lower inflation outcome.

Australia: 

We have the view that the RBA has not done enough to contain the inflation risk. Firstly, it has not achieved negative broad money growth like the ECB and US Federal Reserve, and the abundant supply of money supply is not consistent with inflation near 2.5%.

The RBA strongly believes in the Phillips Curve Theory – a belief that the government with changes to fiscal policy can control the unemployment and price outcomes – we can see in the chart below that higher inflation in the future is likely. Unemployment is well below the full employment level of unemployment – 4.25% – while labour participation is near a record level and wages growth is accelerating.

Beyond the near-term outlook for inflation there are a number of factors that may result in inflation in western developed world being higher for longer. These include:

• Deglobalisation with the West reducing its dependence on China based material and final product supply post the pandemic;
• The transition away from fossil fuel sourced energy to renewable energy involves a substantial investment in new infrastructure that will need to be recovered through higher energy prices;
• Geopolitical risks have increased over the past 12 months with events like the closing of the Red Sea trade route still to impact final prices.

Quote of the update

“Inflation is like toothpaste. Once it’s out, you can hardly get it back in again” – Karl Otto Pehl

We do not include specific commodity price or seasonal updates as this is not out expertise.