Declining inflation pressures and changing interest rate expectations may soon offer respite for Australian agribusiness, but farmers must stay vigilant in 2024 against economic uncertainties and explore options for hedging interest rate risk.

Recent Consumer Price Index (CPI) data revealed inflation cooling more than expected in the 12 months to December 2023, with prices rising 4.1% against a consensus estimate of a 4.3% general increase. For the quarter, prices rose just 0.6% versus expectations of 0.8%.

The Australian share market rose to a record high in the wake of the news, while the Aussie dollar weakened against major currencies. A lower dollar enhances the global competitiveness of our commodities but increases costs for imports like fertilisers and fuel.

Economists and interest rate strategies have emphasised that, while the future direction of interest rates may seem more favourable, the risk of rising borrowing costs persists. Factors such as Stage 3 tax cuts, threats to international shipping, and rising input costs all pose stimuli to inflation and interest rates.

This heightened sensitivity to inflation underscores why interest rate hedging strategies should remain on the table. As one banker said, “Don’t try to pick the market; hedging is about risk management and cash flow management.”

Farm borrowers have several alternative strategies available, with a few of the most common discussed below.

Rate Caps

Caps provide ‘insurance’ against rising interest rates and involve paying a premium to limit exposure. If rates rise above the cap, you pay the lower of the cap and variable rate.

Rate Collars

Collars utilise both caps and floors, establishing a range within which rates can fluctuate. If rates rise above the cap, the borrower is protected. However, if the rate falls below the floor, the borrower will pay the higher rate. This trade-off lowers the cost of the strategy to the borrower.

Swaps

Interest rate swaps involve a cash flow exchange between parties with differing interest rate obligations, allowing borrowers to effectively ‘fix’ their rate. Banks common act as counterparties to offset your risk.

Always check with your bank, broker, or financial advisor on the merits of your risk management strategy.

The text of this article appeared in the Hilltops and Central West Farm magazine on 9th February, 2024.