Higher interest rates will be seen in 2022
Since 2008, the U.S., Economy has operated under a period of historic low-interest rates. These low rates were facilitated by the Great Recession of 2008/2009.
I was in Washington D.C., in September 2008 when news broke on the failure of Goldman Sachs, and it sent shock waves through the economic circles. There was a sense of disbelief among legislators we met with that anything like this could ever happen to the U.S. Economy. The next few years brought a wave of bank failures, investment bank failures, mortgage company failures, business failures, and foreclosed homes. Bank-owned homes in such prosperous locations as Arizona and Florida were selling for a fraction of their former value. The Federal Reserve Bank took immediate action and slashed the Fed Funds rate, the rate upon which banks can borrow money, to near zero. This slash led to a drop in prime rate to 3.25 percent, a historic low rate and as low as prime can go without forcing the economy into a negative rate environment. This action was taken to try to reverse the significant default rate on home, commercial, and agricultural loans.
Fast forward to March 2020. The economy has rebounded nicely. Real estate has returned to historic high values, and the stock market is setting records monthly. Agricultural producers enjoyed a couple of years of historically high prices during this period. The talk among economists was that it was time to start applying the brakes and increase the interest rate gradually. Then came COVID, and the world changed dramatically again. All planned rate increases were delayed, and the government introduced stimulus programs such as the Paycheck Protection Program and numerous payment forgiveness programs. In addition, many people qualified for individual stimulus checks. While economists assured us that this would not create a concerning increase in inflation, the results of these stimulus actions, which were probably necessary to some extent to try and stimulate the economy, have led to inflation rates not seen since the late 1970s and early 1980s. Many remember what this rate of inflation did to interest rates. When I started my banking career in 1980, the prime rate was 18 to 20 percent.
What does this mean for agricultural producers and small business owners? The Federal Reserve has announced that they anticipate three rate hikes in 2022 starting in March. If the skyrocketing inflation is not reversed, they are prepared for at least three more rate increases in 2023. These actions would lead to a prime rate of 4 percent by the end of 2022 and a prime rate of 4.75 percent by the end of 2023. This is assuming their rate increases are in .25 percent increments, as has been the tradition. They could bump it even higher and quicker than this. I predict we will see a prime rate in the 5.25-5.5 percent range by the end of 2023. If you are a producer or a business owner who has variable rate debt, you need to be factoring in what this type of increase will do to your debt repayment obligations. If you are considering a new purchase or planning to refinance existing debt, you should seek out possible fixed interest rates and lock those rates in for as long as possible. Many lenders are already adjusting their offering rates anticipating these rate increases, so the best financing opportunities may have already passed but be prudent and pursue all options available to lock in rates. While a 5.25 percent rate is still an excellent rate historically, many people have a much higher debt obligation than in the past because of expansion and capital purchases. A 2 percent rate increase can have a significant impact on your payments. For example, a 2 percent increase in the interest rate on a $500,000 20-year mortgage adds about $500 a month to the monthly payment.
In conclusion, the long-anticipated increase in interest rates is upon us, barring another catastrophic event like the 2008 Recession or COVID; rate increases will start in the spring of 2022. Therefore, it is prudent to seek refinancing options to lock in interest rates for as long as possible and to factor in the reality of higher interest rates when considering any new financing or capital expansion.
Kim Light is the president and senior credit officer at Heritage Bank of the Ozarks. He may be reached at (417) 532-BANK.
