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Commentary & Voices

Aiming to Defeat Inflation Decisively, the Fed Leaves Interest Rates Unchanged; Gives Clues on Timing of First Cut

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Calling the economic outlook uncertain and citing only “modest” progress toward their 2% inflation objective, the Federal Reserve announced today that it will maintain its benchmark Federal Funds rate in the 5.25% – 5.50% range. The Board of Governors were unanimous in their stance.

The Fed’s decision to stand pat was not a surprise, as most Fed watchers expect rates to remain unchanged until macroeconomic data show either inflation resuming a clear deceleration toward the 2% target or signs the economy – and specifically the jobs market – is rapidly weakening. So far this year, the data have not shown either.

Inflation accelerated at the beginning of the year and showed only a very slight deceleration in April. At the same time, unemployment has remained near 30-year lows while the economy churns out new jobs at a pace well above the pre-pandemic norm. What was supposed to be a “soft landing” for the economy in 2024 has, at times, looked more like no landing at all.

And thus, the Fed is in a bit of a bind as it pursues its dual mandate of full employment and price stability. With unemployment low and the labor market still delivering, the Fed does not want to make the mistake of cutting rates prematurely only to see inflation re-ignite.

There have been some hints in the data that the consumer may be becoming fatigued and the economy is in the early stages of slowing. For example, the housing market and durable goods – big-ticket items that often involve loans of some sort – have shown signs of weakness and downward pressure on prices as inventory builds. However, in the Fed’s view, none of these signals have been conclusive enough in the face of sticky inflation to outweigh the strength of the labor market and justify a rate cut now.

The next Fed meeting, and next opportunity for a rate policy change, will be July 30-31. So, for now, the waiting begins, and that, as Tom Petty reminds us, is the hardest part. Based on the latest data and the Fed’s statements, markets now see September as the earliest date for a possible initial cut of 25 basis points.

With no immediate relief on cost or availability of credit coming out of this meeting, the market focus turns to digesting details of the decision. Analysts will dissect and debate the meaning of statements by Chairman Jay Powell and Fed board members and analyze the latest “dot plot,” looking for clues to the timing, pace and direction of rates.

It’s a little like reading tea leaves, but based on the totality of what came out of this meeting, there are still expectations that rates will be moved down. As Chairman Powell noted, the FOMC Board members are fairly evenly split on expectations for one or possibly two cuts still this year, but the decisions will depend on the totality of the incoming data. And even then, the Fed does expect their policy stance to remain restrictive for some time.

Interest Rates and the Auto Market

The last time the Fed made a move was July 2023, when rates were moved higher by a quarter point. This means that by the next FOMC meeting, we will have seen the Fed Funds rate hold at a 23-year high – a level that is considered restrictive – for a full year.

These sustained higher interest rates have been a significant financial headwind for mid-to-lower income households over the last year and are impacting demand in rate-sensitive sectors like real estate and autos.

In the retail automotive space, both new and used vehicle sales volumes are likely at or near their maximum potential until interest rates come down because many buyers with lower credit scores who were able to purchase a vehicle in the low-rate world before 2022 are unable to afford a vehicle at the current rates.

New-vehicle sales have been running at about a 15.5-million-unit pace for the last year. May saw an uptick to a 15.9 million seasonally adjusted annual rate (SAAR), the highest point thus far in 2024, but those numbers were juiced in part by more aggressive incentives and discounts, which were also at a high point for the year. In the years just prior to the pandemic, when rates were lower and incentives were even higher, the SAAR for new vehicles was routinely above 17 million units. The difference between now and then is all about the affordability equation, at the heart of which is higher interest rates.

Interest rates are also vexing dealers. Retailers are feeling pressured by lower sales volumes and lower profitability as big increases in inventory floor planning costs, also interest-rate-driven, eat away at profit margins. In the most recent Cox Automotive Dealer Sentiment Index, released earlier this month, franchised and independent dealers alike pointed to high interest rates as the No. 1 factor holding back business.

The vehicle market will remain relatively range-bound until we start to see interest rates finally move materially lower. Welcome to the waiting game.

Mark Strand
Senior Director of Economic and Industry Insights

Mark Strand provides perspective on industry trends informed by the best available internal and external market data and research to address the industry’s critical questions. He has spent the last ten years providing insightful connections across market dimensions, including demographics, economic indicators, industry trends, shopping behaviors and preferences, and vehicle sales to illuminate implications, risks and opportunities to inform decision making.

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