I'm Matt Erickson, agriculture, economic and policy advisor for Farm Credit Services of America. I'd like to provide a summary of the U.S. economy today, what we can expect in 2025 and what this means for producers.

In December, the Federal Reserve enacted a 25-basis point cut, lowering its borrowing rate between 4.25% and 4.5%. Since the first rate cut back in September, the Fed has reduced rates by a total of a 100 basis points. Inflation continues to soften from the peak scene from 2022, but the Federal Reserve's preferred measure of inflation. The personal consumption expenditures price index has shown a modest increase in recent months with a 0.1% rise in November 2024.

Over the past year, the core PCE inflation rate has fluctuated around 2.6% and 2.8%, indicating a relatively stable trend in consumer prices, but also a stable trend and underlying inflationary pressures.

Some of the stickier components of core inflation include services, housing and healthcare. Housing prices, which tend to be more rigid, showed signs of cooling in November rising just 0.2%. Over the past three months, core inflation, which excludes volatile food and energy components, has shown a slight deceleration. The three-month annualized rate of core inflation at 2.5% decreased from 2.8% in October. This indicates a slowing pace of underlying inflationary pressures. Looking at the past six months, the core inflation rate increased slightly from 2.3% in October to 2.4% in November but has remained relatively stable since August.

This stability suggests that while there are still inflationary pressures, they are being managed effectively. The Fed cutting rates comes at a time when U.S. economic growth remains solid, generally around an annual growth rate of 2% to 3%.

As we entered 2025, the U.S. continues to remain in solid footing. As of the third quarter of 2024, U.S. GDP initially increased at an annual rate of 2.8%, then got revised upward to 3.1%. This growth was driven by increases in consumer spending, federal government spending, and business investment. The Atlanta Federal Reserve is also forecasting 2.7% growth in the fourth quarter of 2024, largely driven again by consumer spending.

The positive outlook in the U.S. is based on continued strength and consumer spending. However, a cautious approach from the Fed helps manage both growth and inflation effectively. The U.S. consumer remains resilient and one of the major reasons is the increase in consumer wages. Recent data shows that real wages and incomes have been growing, which supports consumer spending. As of November 2024, nominal hourly earnings in the U.S. average $35.59 per hour, up approximately 4% from the same time last year. For context, from 2007 up until the COVID-19 pandemic, average hourly earnings grew 2.5% year over year. Since April 2023, inflation adjusted wages have been rising faster than inflation, meaning that workers purchasing power has been improving, allowing them to afford more goods and services despite rising prices. Increased consumer wages can have several impacts on agriculture. Higher wages have led to increased costs for farmers, especially if they need to pay more and compete for labor. According to USDA, farm labor expenses increased over 6% from 2023 to 2024. Second, increased wages likely lead to more disposable income, resulting in consumers likely to spend more on higher quality food. This can boost demand for a variety of agricultural goods.

Even as consumer debt continues to increase, aggregate measures of debt relative to income remain low. Historically, since 2007, consumers inflation adjusted debt to income ratio averaged 0.83%, meaning consumers borrowed in aggregate 83 cents for every $1 of income. The ratio was above one during the 2008, 2009 financial crisis, meaning consumers and aggregate borrowed more than their available income. As a result, delinquencies on total debt increased.

Today as of quarter 3, 2024, the real debt to income ratio stands at 0.72. While at the same time, nearly delinquent debt of 30 plus days also remains low, in the 4% range. While consumers are taking on more debt, their incomes also are rising. This is helping maintain a balance. Household debt service payments also remain relatively low as a percent of disposable personal income. It currently is at 11.3%, slightly below the 11.9% average dating back to 1981. However, it is increasing and the upward trend is worth monitoring in 2025.

But let's dive a little bit deeper. While the total amount of nominal credit card debt in the U.S. has reached record levels, the inflation adjusted figures provide a more nuanced picture. As of quarter 3, 2024, inflation adjusted credit card debt is 6.4% below its peak from quarter four of 2008. This suggests that, although nominal debt levels are high, they are not as alarming when adjusted for inflation. However, more consumers are struggling to pay off their credit card debt. According to the New York Federal Reserve, approximately 8.8% of credit card balances are considered 30 or more days delinquent. Since 2003, the average has been 7.9%. While the inflation adjusted debt to income ratio is low for the consumer population at large, the higher the predicted delinquency rate suggests some consumers may be feeling financial stress. If personal income growth keeps pace with debt, U.S. consumers will likely continue to borrow. However, if it doesn't, consumers may be less inclined to spend and experience higher financial stress. This, in turn, would make the economy more vulnerable to shocks such as increased debt delinquencies, especially since the personal savings rate of consumers is relatively low at 4.3%. It will be important to watch wage growth combined with the cost of caring credit card debt and low personal savings in 2025.

Consumer wages remain strong because of a tight labor market. The U.S. economy added a robust 256,000 jobs in December 2024, significantly surpassing expectations of 155,000. This strong job growth brought the unemployment rate down to 4.1%, reflecting the resilience of the labor market despite high interest rates and economic uncertainties. Key sectors contributing to this growth included private healthcare, retail, leisure, and hospitality and government. The December jobs report underscores the strength of the U.S. economy as it closed out 2024 on a positive note.

However, what's good news for the U.S. economy may not be good for the stock market as expectations for more interest rate cuts may be dampen. We still have more job openings than unemployed people in the United States, which keeps the labor market tight and wages elevated. But job openings have declined in the past six months. From early 2007 to pre COVID-19, the average ratio of job openings to unemployed persons was 0.57, with average hourly earnings growing at 2.5% year over year. This ratio stands today at 1.14 job openings per unemployed person with average hourly earnings growing at 4% year over year. Layoffs remain low, about 7.9% below the average since 2001 indicating employers are holding onto employees, but they did pick up in the last six months. Meanwhile, hiring and quits slow significantly in 2024. Together these trends indicate job seekers may have a tougher time in today's labor market. Hiring may bounce back if the Fed continues to cut interest rates as employers may invest more in businesses if borrowing costs or lower. But the Federal Reserve is still in inflation fighting mode and will need to carefully balance its policies to maintain economic stability without exacerbating unemployment.

Immigration has also played a significant role in the U.S. labor market. Since the COVID-19 pandemic, the foreign-born employment level has increased 16%. While the native-born labor force has increased only 1.5%. Foreign-born workers have helped address labor shortages across various industries, including healthcare, agriculture, and construction. By increasing the labor supply, foreign-born workers have helped moderate wage growth. Yes, wages are elevated, but the growth would be more significant with fewer workers.

The incoming administration has said immigration enforcement is a priority. How the administration prioritizes people for removal will determine the economic impacts. This could include underlying inflationary impacts such as, one, labor shortages. Deporting large numbers of immigrants would create labor shortages and key industries such as agriculture, construction, and healthcare. These sectors rely heavily on immigrant labor and their absence would lead to reduced productivity and higher labor costs. Second, increased costs. With fewer workers, available businesses may face higher operational costs, which could be passed on to consumers in the form of higher prices for goods and services. Third, economic contraction. The reduction in the labor force and consumer base could lead to a contraction in economic growth. A smaller workforce means less economic output and reduced consumer spending can further slow down the economy. And fourth supply chain disruptions. Industries that depend on immigrant labor for specialized roles may experience disruptions leading to inefficiencies and increased costs throughout the supply chain.

Last month, the Federal Reserve released a quarterly summary of economic projections that included GDP growth slowing, but remaining above 2% through 2026, inflationary pressures managed but remaining above 2% out to 2027 and stable unemployment remaining around 4.3%. The Fed also provided insight into their future rate decisions through a dot plot that records each Fed official's projection for the central bank's key short-term interest rate. The Fed signal plans to reduce borrowing costs in 2025 by a total of 50 basis points resulting in a target range between 3.75% and 4%. The market viewed these projections as hawkish since the Fed back in September signaled 100 basis points worth of cuts in 2025. The projected federal funds rate of 4.4% in 2024 and 3.9% in 2025 suggests that borrowing costs will remain relatively high in the near term, which could impact sector sensitive to interest rates such as real estate and consumer discretionary spending.

Longer term, the Federal Reserve's expectation for the federal funds rate increased from 2.9% in their September projection to 3% in December. This projection represents the median value of the range forecast established by the Federal Open Market Committee and reflects the rate to which the economy is expected to converge over time, assuming no further economic shocks and appropriate monetary policy.

The increase in long run expectations signals several key points about the economy. First, economic strength. The Fed's higher rate forecast suggests confidence in the economy's ability to grow sustainably without needing extremely low interest rates. This indicates a robust economic outlook. Second, inflation management. It reflects the Fed's commitment to controlling inflation. By projecting higher rates, the Fed aims to prevent the economy from overheating and keep inflation near its 2% target. And third, a policy shift. This change marks a shift from the ultra low rate environment that was necessary during the pandemic to support the economy. It indicates a move towards more normalized monetary policy.

How do the Feds projections align with market expectations? The dotted red line and the solid blue line represent two distinct time periods of the CME Fed Watch tools, highest probability projection of where the upper limit of the federal funds rate will be out to 2025. The two distinct time periods are from the market's projection on October 3, 2024, which was a couple weeks after the Fed's first rate cut and the more recent January 10 projection. The two green dots show the median federal funds rate projections for 2024 and 2025 from the Fed summary of economic projections released in December.

Since its first reduction in September 2024, the Federal Reserve has adopted a more hawkish stance with its rate cuts. Initially, the Fed implemented several rate cuts to address economic challenges. As a result, back in October, the market projected the federal funds rate between 3% and 3.25% by June of 2025. However, persistent inflation, strong economic growth, and a resilient labor market has prompted the expectation of the Fed to be more conservative with rate reductions. As a result, the market now projects only 25 basis points worth of reductions out to 2025, which is less cuts than what the Federal Reserve projects.

This shift suggests that the Fed is prioritizing inflation control over aggressive rate reductions, which could have implications for borrowing costs and economic growth. The most obvious impact for producers is higher borrowing costs for farm loans and operating expenses. Increased financing costs for land purchases could be a headwind for the real estate market. Also, higher interest rates often result in a stronger U.S. dollar, which can make U.S. agricultural products more expensive on the global market and reduce export competitiveness.

What factors in 2025 will the market be focusing on as it relates to inflation and interest rates? First, the bond market. Breakeven inflation rates are derived from the yields of nominal treasury bonds and treasury inflation protected securities. They indicate market expectations for future inflation. A rising breakeven rate can prompt tighter monetary policy and reflect growing inflation concerns. Since the Fed's first rate cut in September, the 5-year and 10-year breakeven rates have increased 46 basis points and 26 basis points indicating expected average inflation of 2.44% and 2.38% over the next five years and 10 years. Interestingly, breakeven inflation rates are rising at a time when retail gasoline prices have been falling. Despite 100 basis points worth of cuts from the Federal Reserve, the yield on the 10-year treasury has increased 98 basis points since the September rate cut. We saw a bigger increase once over the past 50 years during a rate cutting cycle in the early 1980s.

Today's increase is due to several factors, all of which merit attention. First, market recalibration or the shift in market expectations for fewer rate cuts and in turn high bond yields. Second, strong economic data. Many recent economic indicators point to a resilient economy prompting investors to demand higher yields on long-term bonds. Third, inflation. Investors are seeking higher returns to compensate for the anticipated erosion of purchasing power over time. And fourth, federal debt. This is a $36.2 trillion problem. For context, $36.2 trillion in U.S. national debt equals more than 107,000 per U.S. citizen and 271,000 per taxpayer. If the U.S. were to increase debt levels, we could see higher bonds as a result of investors demanding compensation for perceived risks. These factors collectively are contributing to the rising 10-year treasury rate reflecting broader economic conditions and market sentiment. Second, consumer expectations at consumers expect inflation to rise. They may start buying more now, which can push prices up further.

To illustrate, let's look at how the threat of tariffs can impact spending and the economy. First, higher prices tariffs increase the cost of imported goods, and businesses often pass these higher costs onto consumers leading to increased prices for a wide range of products. Second, inflation expectations. When consumers anticipate tariffs, their expectations for inflation increases, which can lead to changes in spending behaviors such as buying goods before prices go up. Third, market sentiment. The threat of tariffs can also affect market sentiment leading to volatility in financial markets. This uncertainty can further influence consumer expectations and economic behavior.

Here we have estimates of one-year inflation expectations from the University of Michigan and the New York Federal Reserve Bank. In November, the university's estimate was 2.6% compared to 3% from their federal reserve bank's estimate, which slightly increased from October. This tells us a couple things. First, higher anticipated inflation may encourage spending now rather than later. Second, it may influence consumer spending habits through accelerated or even bulk purchases reduce savings due to the expectation that money will lose value over time, and cost consumers to potentially switch to cheaper alternatives in order to manage their budgets better.

Over a three-year outlook, inflation expectations from the New York Fed rose from 2.5% to approximately 2.6%, suggesting a growing concern about future price increases. Policy makers will monitor these expectations closely as they can impact monetary policy and economic stability.

Third, the state of the stock market. Despite the S&P 500, dropping 2.7% in December, it has increased 5.3% since the Fed's first rate cut in over 26% from 2023 to 2024.

While a strong stock market alone doesn't cause inflation, it can't contribute to inflationary pressures. Overall while the aftermath of rate cuts can be uncertain, historical data indicates a tendency for the S&P 500 to perform well in the longer term.

So what can producers do now as they plan for 2025? Your existing debt structure and any new debt needs to work in the current interest rate environment. Solvency measures are important in evaluating the financial risk and borrowing capacity of your business. The ability of your business to pay all its debts, if it were sold today, needs to be understood by any business owner. Two critical solvency ratios in today's economic environment are the farm debt-to-equity ratio and the debt-to-asset ratio. The debt-to-equity ratio reflects the extent to which farm debt capital is being combined with farm equity capital. Whereas the debt-to-asset ratio reflects what proportion of total farm assets is owed to creditors. Both are critical when deciding if an operation can take on additional loan or another round of financing. For your operation’s debt-to-equity ratio, target a desirable number that's less than 66%. For your debt-to-asset ratio, an ideal target is less than 40% because typical agricultural operations can more effectively sustain that level of debt burden. Try not to have a debt-to-asset ratio exceeding 50%.

Your ability to repay term debts is also critical in today's environment. One ratio to consider is the term debt and capital lease coverage ratio. This ratio reflects whether your farm produced enough cash to cover all farm and non-farm intermediate and long-term payments. To calculate the ratio, you'll need to add net farm income from operations, total non-farm income, depreciation expense and interest on term debt and capital leases, followed by subtracting total income, tax expense and family living. Once you calculate the numerator, you'll divide that number by the principal and interest payments on term debt and capital leases. Shoot for a ratio of greater than 1.5. A ratio of less than one would be considered higher risk. If your operations ratio is less than one, your operation cannot serve as death.

Economic conditions are expected to remain tight in 2025 due to high input costs and lower commodity prices. Factors such as a stronger U.S. dollar potential trade disputes and immigration policies could also add to the volatility and uncertainty. Given tighter margins and the potential for financial losses, it might be important to consider enhancing your crop insurance strategy for 2025. Evaluate additional coverage options such as the supplemental coverage option and the enhanced coverage option, which can be layered with existing crop insurance policies to provide more substantial revenue protection. It's also important to note that the ECO subsidy has increased for the 2025 crop year further incentivizing producers to consider this option.

Crop insurance should always be a central part of your risk management strategy, but producers may need to get creative to protect revenues in 2025. Stay in contact and work with your crop insurance agent early to get a good sense as to what might work best for your farm.

Producers will need to navigate these headwinds carefully, and we at Farm Credit are here to help. Thank you for tuning into this update. I hope everyone is having a great start to the new year and have a great 2025.