Matt Erickson, agriculture economic and policy advisor for Farm Credit Services of America, explains the specific market indicators that guide the Fed’s decision process, possible future cuts, and what this means for producers.
Hello, I'm Matt Erickson, agriculture economic and policy advisor for Farm Credit Services of America. I'd like to recap with you the Federal Reserve's November meeting and what this means for producers.
The November meeting comes at a time when US economic growth remains in good shape. A healthy gross domestic product for the United States is generally considered to be at an annual growth rate between two and 3%.
In the third quarter of 2024, the United States Gross domestic product grew at an annual rate of 2.8%, slightly below the expected 3.1% and down from 3% in the previous quarter.
The growth highlights the ongoing strength of the US economy driven by robust consumer and government spending. Despite some areas of slowdown.
Despite the positive growth and increase in imports offset some of the gains. Overall, the economy continues to expand supported by resilient consumer activity and government expenditures even amend concerns about inflation and interest rates.
Robust consumer spending continues to be a key driver of US economic growth, indicating that despite various challenges, the economy is maintaining its momentum.
On a per capita basis. Real disposable incomes have grown 2.6% from last year remaining above the 2.2% average since 1960. Despite concerns about inflation, consumer spending continues to be a driving force in the economy. The increase in purchasing power isn't the same for all consumers. Some aren't able to keep up with rising costs.
But the data shows that by this measure, consumers purchasing power is relatively strong. More disposable incomes means individuals can afford better goods and services.
Rising average hourly earnings typically indicate a strong labor market in economic growth. While stagnant or declining earnings can signal economic challenges.
As of October 2024, nominal hourly earnings in the US average $35 and 46 cents. Up approximately 4% from the same time last year. When adjusted for inflation, average hourly earnings increased 1.5% and have been rising faster than inflation since April 2023. However, credit card balances have increased significantly since 2021, while consumers' personal savings rates remain below average. The latest data indicates that US consumers collectively owe $1.14 trillion in credit card debt, a record high in nominal terms. However, in inflation adjusted terms, this means slightly below the recessionary period of 2008 and 2009.
US credit card accounts delinquent by 90 or more days is approximately 11%. The highest since quarter one of 2012. With the average interest rate on credit cards, approximately 25%. High credit card debt will likely continue to strain household budgets, particularly with rising food and housing costs.
Meanwhile, the personal savings rate has declined for three straight quarters as of quarter 3, 2024. It stood at 4.8% before the pandemic, the quarterly average was 5.3%. Since 2003, consumers have a smaller buffer for unexpected expenses as the savings rate slows.
The Federal Reserve's goal is to restore price stability in the marketplace without a significant increase in unemployment. The unemployment rate remains low at 4.1% and the US labor market remains strong. During the past 50 years, the unemployment rate has averaged 6.2% while unemployment rates during non-res recessionary periods since 1974 have averaged 6%.
However, there are signs that the US labor market is cooling. Over the past six months and year, layoffs have increased while hiring and quits have also slowed significantly. Job openings are also declining while job openings per unemployed person remain above historical averages, there are currently just over one job opening per unemployed person the lowest since May of 2021. Non-farm payroll employment was essentially unchanged in October with a modest increase of 12,000 jobs. Three hurricanes, Francine, Helene, and Milton influenced the labor market along with worker strikes in the manufacturing sector. However, there have been 14 downward revisions since January of 2023 suggesting the US economy is creating fewer jobs than originally reported.
The labor market remains tight, but the market is cooling. The Federal Reserve will need to carefully balance its policies to maintain economic stability without exacerbating unemployment.
So where do things stand today? Last week, the Federal Reserve enacted a 25-basis point reduction, putting its benchmark policy rate between 4.5% and 4.75%. At the same time, US core inflation remains steady at 2.7% year over year growth. The Fed's goal remains 2% inflation.
The Fed's move is in step with its goal of supporting economic growth while also mitigating risk that could further cool the labor market. The decision came as core inflation, excluding food and energy remains around 2.7%. Services inflation remains sticky, indicating persistent underlying pressures in certain sectors of the US economy. Service sector categories such as motor vehicle insurance and the food services such as restaurants continue to remain sticky as labor costs remain elevated. The pullback in shelter inflation such as rents also has been slower than expected.
So what has the inflation data meant over the past three months and six months? Three- and six-month annualized rates of core inflation are important to monitor. To get a sense of the most recent trend in prices, these annualized rates tell us what inflation will look like if it rose for the full year at the same rate as it did in the last three months, as well as over the last six months. The three-month annualized rate of core PCE inflation at 2.4% has increased two consecutive months from 1.7% in July and 2.1% in August. The six-month annualized rate of poor inflation has declined over the past four months from 3.28% in June to 2.3% in September.
So what does this mean? Well, the six-month annualized figure is trend towards the fed's 2% target. The slight uptick in the three-month annualized figure reminds us that inflationary pressures haven't fully disappeared. This should keep the Fed on a gradual pace of rate cuts moving forward.
Is the market aligning with this expectation? Compared to the Fed, the market anticipates a lower pace of rate cuts in 2025. The CME Fed Watch tool uses prices of fed funds futures contracts on the CME to project the real time probability of federal funds rate changes. From the chart. The solid red and blue line show the upper limit of the CME Fed Watch tool projection for the federal funds rate through the end of 2025. The red line projections are from last month, October 3rd, and the blue line shows updated market projections as of November 12th. The green dots from the chart indicate the median federal funds rate projection for 2024 and 2025 based on the fed's September summary of economic projections.
There are two points from the chart that need discussed. First, comparing the blue and red lines market expectations today signal less reductions out to 2025 than what the market had projected last month. The CME Fed Watch tool today project 75 basis points worth of reductions out to 2025, whereas last month, the market signaled 150 basis points. The market appears to signal that inflationary pressures continue to exist and the Fed won't be as quick to reduce rates as previously thought. Second, current market expectations and Federal Reserve projections are slightly misaligned. At an upper limit of 4%, the market today projects fewer cuts of 75 basis points out to 2025 compared to the fed's September projections. The Fed will update its projections in December.
Breakeven inflation rates are important indicators of market expectations for future inflation derived from the yields of nominal treasury bonds and treasury inflation protected securities. Since the Fed's first rate cut up 50 basis points in September, the five year and 10-year break even rates have increased 0.45 percentage points and 0.23 percentage points to 2.43% and 2.35% respectively.
Breakeven inflation rates are crucial for understanding economic conditions as well as making informed financial decisions. A rising breakeven rate may prompt tighter monetary policy to combat potential inflation and might also reflect shifts in market sentiment as investors become more concerned about inflationary pressures. Understanding inflation expectations can help in budgeting and investment strategies, ensuring that investors and businesses can maintain purchasing power over time.
The recent increase in the five-year and 10-year treasury rates can be attributed to several key factors. First, economic resilience. The US economy has shown strong performance, particularly in the jobs market. The resilience suggests that the Federal Reserve may maintain higher interest rates for a longer period than previously expected, which tends to push Treasury yields up. Second market adjustments. Investors are rethinking their expectations regarding future interest rate cuts by the Fed. The market is now pricing in a more cautious approach to further reductions leading to higher yields. Third, inflation concerns. Although inflation has been somewhat stable in trending towards the Fed's goal of 2%. Ongoing economic strain raises concerns about potential upward pressure on prices. This can lead to higher long-term yields as investors demand more return to compensate for inflation risks. And fourth, increased government borrowing. A significant amount of new government bonds has and are expected to be issued in 2024, which can contribute to rising yields as supply for bonds increases.
Consumer expectations are generally considered a leading indicator of inflation. As the belief that prices will rise in the future can influence current spending and pricing decisions by businesses potentially leading to actual inflation increases. Essentially, if consumers expect inflation to rise, they may start buying more now, which can push prices up further. As a result, consumer expectation is a key gauge for inflation. Here we have estimates of one-year inflation expectations from the University of Michigan and New York Federal Reserve Bank. In October, the university's estimate was 2.7% compared to 3% from the Federal Reserve Bank September estimate. This tells us a couple things. First, the expectation has been relatively unchanged indicating some stabilization in consumer outlook despite economic fluctuations. Second, higher anticipated inflation may encourage spending now rather than later. Over a three-year outlook, inflation expectation from the New York Fed Rose two 2.5% to approximately 2.7%, suggesting a growing concern about future price increases.
Policy makers will monitor these expectations closely as they can impact monetary policy and economic stability. Despite market volatility since the federal reserve's first rate cut on September 18, the S&P500 has shown a generally positive trend. Historically, the S&P500 often experiences a dip in the media aftermath of the rate cut, but typically rebounds within a few months. As shown in the chart, the average return three months after a rate cut is usually positive. On average, the S&P500 tends to gain approximately 3% one year after the first rate cut. While there may be volatility initially, the market often stabilizes and grows as lower interest rates stimulate economic activity. Following the most recent cut in September, the S&P500 saw fluctuations but has generally trended upward. One month after the first rate cut, the S&P500 increased 4.4% and almost two months after the first rate cut, a 6.7% increase. This reflects investor optimism about economic growth and corporate earnings.
Overall while the immediate aftermath of rate cuts can be uncertain, historical data indicates a tendency for the S&P500 to perform well in the longer term. What can producers do now as they plan for 2025? If history teaches us anything about the cyclical nature of agriculture, costs will likely remain elevated. While margins remain tight for 2025, it will be extremely important for producers to know and scrutinize their production costs, develop and implement a marketing plan and stress test that marketing plan that focuses on costs and breakeven levels to manage risks.
While future rate cuts are likely, the Fed continues to face underlying inflationary challenges in an uncertain post-election outlook that could threaten to reignite inflation. While it's likely that projected rate cuts will provide some cost savings to producers in 2025, be mindful that it may not be as much as previously anticipated from the market. Economic conditions can change quickly in the current environment based on market sentiment, policy changes and updated market data. Continue to scrutinize your 2025 production costs and tools such as crop insurance should continue to be at the center of any risk management strategy. Second, assess your working capital position and aim to have a minimum of 20% of gross revenue per acre. Effective working capital management mitigates financial risk associated with cashflow fluctuations, commodity price volatility, or any unforeseen business disruption. Third, lengthen loan repayment periods if needed. Extending payments out a couple more years can preserve working capital positions if it's needed for your operation. Fourth, we do not forecast significant opportunities to refinance debt in the short term. This means any new debt you take on and your existing debt structure needs to work in the current interest rate environment. Finally, stay current on the overall interest rate environment and understand what it means for your operation in a tight margin environment. Finding ways to manage and cut costs while building working capital and gaining efficiencies will be critical for bottom lines in 2025.
Thank you for tuning into this update. I hope everyone had a safe and successful harvest and have a wonderful Thanksgiving holiday.
