After years of cheap money, central banks around the world have been tightening the financial leash. In the United States, for example, benchmark interest rates currently stand at 5.5 percent; in Europe, they reach 4 percent, a new record since the introduction of the Euro. Why does all this matter for global grain markets?

One of the immediate effects of escalating interest rates is the restriction they impose on credit access for market participants. In the United States, farm lending softened considerably in the first half of 2023, according to a recent update from the Federal Reserve Bank of Kansas City. While agricultural production is unlikely to be affected this season, the elevated borrowing costs add to already high farm expenditures in view of still inflated input prices. If these trends persist, high interest rates could thus stifle long-term production growth.

Grain traders, who rely heavily on external financing to manage the time gap between grain procurement and sales, are also experiencing the ripples. Higher interest rates raise the costs associated with grain storage, as the increased cost of capital makes it more expensive to hold unsold grains. While alternative lenders, such as private equity funds, may close some of the funding gap, these are unlikely to fully replace traditional bank financing. Also, these alternative financial resources tend to be limited to larger firms, so smaller and medium-sized traders risk to be left out.

Rising interest rates also reduce liquidity in financial markets, including those for agricultural derivatives. Lower liquidity can in turn prompt investment funds to liquidate positions. This may result in a sell-off in grain markets and a consequent dip in grain prices, as observed earlier this year. The impact of the sell-off in March was particularly significant as it occurred amidst persistently high price volatility in markets. Adequate liquidity is pivotal for the smooth operation of markets, including price discovery mechanisms.

Higher interest rates also impact grain markets through a currency effect. Thus, the Federal Reserve raising rates can be expected to lead to a stronger US dollar. A strengthening of the US dollar will in turn drive up the cost of dollar-denominated grain imports, which is particularly problematic for low-income food deficit countries that rely on these imports to feed their populations.

Are these temporary phenomena that will subside soon? While the initial reversal in monetary policy was to respond to "transitory price inflation", central banks now emphasize that the return to price stability might require longer-term efforts. Thus, high interest rates seem here to stay, and with them the potential adverse impacts on agricultural markets.