The Long-Term Path for Interest Rates

No matter how much we get used to it, rarely has the global economy forced us to navigate waters so seemingly calm, but with such potential for swell. On a historical basis, grains remain expensive, fertilizer prices have–surprisingly–fallen over the winter at the world level and the downward trend in inflation is continuing. In a way, the market is waiting for the next explosion, which unfortunately may well come, again, from Ukraine.

In the meantime, at home, the slowdown in consumer price growth suggests a rate cut in the medium term. Our patience will be tested: a cut is not expected before the end of the year, and central banks will be cautious in this regard. They will be very wary of a revival of inflation, especially in a context of full employment. So, beyond being patient, one should not expect rates to return to their pre-2010 level, since many inflationary factors will persist.

First, the energy transition. The movement will be gradual, but over the decades fossil fuels will make more room for wind, solar, hydroelectricity, etc. This transition will require massive investments and will be inflationary as a corollary. Add to this the geopolitical tensions on a global scale. The ambiguous position of many countries–including China–with regard to the RussianUkrainian conflict raises the spectrum of an East-West split similar to that of the Soviet era. Thus, taking as a basis the increasing fluidity of world trade that has marked the last decades, the current political uncertainty will lead many countries or companies to review their strategic choices. Managing this risk increases the cost of doing business and generates inflation.

Another inflationary factor, possibly the most important one, is demography. Not only in the West, but also in China, the age pyramid suggests several tight years in terms of labour availability. On the one hand, companies will have to be more attractive, especially through higher salaries. On the other hand, an inevitable wave of automation is starting or continuing in several sectors of activity. These are all factors that fundamentally generate inflation, which leads to the belief that a policy rate of around 3 to 3.50 per cent in the long term is more likely than the very low rates that have prevailed for more than a decade.

In the shorter term, the current business environment is relatively calm. It may be a bit of a stretch to talk about calm when interest rates are nearly triple what they were just 18 months ago and the war in Ukraine is looking like a stalemate. The fact remains that inflation is easing, which is reassuring. This suggests that future rate movements will be downward, as long as inflation continues to react as expected.

Risk management in agriculture is complex. In addition to the interest rate waltz, grain inventories are rather tight overall. So tight that weather shocks in key production areas have big impacts on markets. After the Canadian Prairies in 2021 and Europe in 2022, it was Argentina’s turn to suffer from drought. Although the current state of the markets suggests a year of positive margins in crop production, experience has taught us to be prepared for anything.