2001 Has Been a Year of Surprises

by Dean W. Moreau, president and CEO, Yankee Farm Credit

2001 has surprised me twice.

The dramatic reduction in market interest rates from January through May was my first shock. While market gurus expected some Fed easing, few accurately predicted the speed and magnitude of the rate cuts. In the past five months the federal funds rate fell five times, from 6.5 percent to 4.0 percent. Only one other time in my 24-year Farm Credit career have I seen rates drop so far, and so fast. And that was from 1981 to 1982.

At the same time, many have been puzzled why longer term market rates did not follow suit. As short-term rates crept upward from May to December last year, longer term rates drifted downward.

Why? Because higher short-term rates create a drag on the economy, which reduces the risk of inflation. If you are a longer term bond investor, you hate inflation. It reduces purchasing power (value) of your interest. Lower inflationary risk means longer term bond investors don't need a rate "premium" to protect against inflation, allowing longer term rates to fall.

On the other hand, short-term rate cuts stimulate economic activity. With more economic growth expected, long-term bond investors are fearful of future inflation and demand higher rates as inflation "insurance," so long-term rates normally increase.

Try to remember this the next time you think about converting your Yankee responded to the Fed actions by reducing your variable rates four times from February 1 to June 1, with a total drop of 2.5 percent. That's more than $4.5 million in annual interest savings for our membership. In case you are wondering, I think Greenspan still has another quarter to half percent rate cut left in him this year. Loan to a longer term fixed rate. The best time to switch from variable to fixed is usually just as the Fed starts to lower rates. If you wait too long, the market becomes convinced that the Fed's easing will eventually heal our economic woes, sending longer term rates north.

My second surprise is how well Yankee's credit quality is holding up in spite of a very difficult 2000 for both dairy and timber customers. As of May month-end, the percentage of acceptable loan volume is actually up slightly from year-end. This is not what I expected, with last year's low milk prices, poor feed quality and deteriorating margins between stumpage costs and finished lumber or chip prices.

While many customers suffered dramatic reductions in accrual net earnings, operating cash flow was usually sufficient to cover debt service obligations and living expenses. Additionally, members reacted very quickly, in fact faster than I've ever seen, to falling commodity prices and sharply curtailed capital expenditures. As such, balance sheet positions on 12.31.00 were still strong, substantially unchanged from a year earlier.

My sincere compliments to our membership who weathered a really tough 2000 in good shape. With higher milk prices, lower interest rates, continued low grain prices and good local growing conditions, 2001 looks like the year for some real gains in members' net worth

This letter appeared in the Summer 2001 issue of Financial Partner (F.P.) magazine, Yankee Farm Credit's customer publication. Click here if you would like to start receiving F.P. magazine in the mail.

© 1999-2005 Yankee Farm Credit, ACA. All rights reserved.