Fed Rate Cut Likely Won’t Influence Auto Loan Rates

As was widely expected, the Fed officially cut the short-term rate policy by a quarter point, so their rates are back to the range we had last August before the September 2018 increase. Citing global developments and muted inflation pressures, the Fed decided to cut rates even though there was dissension in the vote with two members favoring no cut and one favoring a half a point cut. They also purposely avoided communicating clear future plans but instead affirmed they would continue to “act as appropriate.”

The quarter-point cut likely won’t influence auto rates as was the case following the July cut. Short-term rate policy does not directly impact longer-term rates on consumer loans like mortgages and vehicle loans.

We did see declines in long-term bond yields and mortgage rates in August, so we can acknowledge that the end of quantitative tightening helped long-term rates come down. However, we didn’t see the downward August trend in bond yields translate to meaningful declines in auto loan rates.

Auto loan rates on average for both new and used vehicles remain near 9-year highs. A key reason for the divergence with bond yields and mortgage rates is a risk premium. About 20% of auto finance is subprime. While the 10-year Treasury yield was dropping in August, subprime auto loan rates increased on average by more than 20 basis points.

An inverted yield curve signals credit tightening. Lenders seek compensation for higher risk, and that means higher rates for real borrowers even if central bank policy rates and Treasury yields are declining.

Despite the fact that auto loan rates did not decline in August, the retail market was strong for both new and used vehicles. The new market benefitted from a surge in incentives as dealers and manufacturers worked to reduce inventories. Lower prices helped average new-vehicle payments come down marginally despite high rates.

The Fed’s prior action to cut rates and stop quantitative tightening didn’t help the auto market last month, but their actions didn’t hurt it either. Time will tell if this additional rate reduction will actually materialize into real, observed rates on auto loans. For now, we doubt rates will come down, and we think September retail sales will depend on high incentives.

Consumers continue to deal with the most expensive new vehicles in history and record-high finance payments. If manufacturers hope to sell more of these expensive vehicles, they will need to keep incentives high. Lower bond rates could make rate subvention less expensive for manufacturers, so we may see more zero- or low-rate offers. However, we may not see many low-rate offers extended to borrowers with less-than-perfect credit.

Keep an eye on used-vehicle values as well. Higher incentives and more discounting on new vehicles reduce demand for used cars and puts downward pressure on used-vehicle prices. If a new version of a model is now priced less, the market eventually cascades that discount down to its older siblings.