Fed Actions Speak Louder Than Words About Rate Policy; Those Actions Portend Higher Rates Ahead

As expected, the Fed left interest rates unchanged today, at least as it relates to official short-term rate policy. We have now had two meetings with no change in rate policy, yet rates keep rising. The Fed is getting more restrictive higher rates while pretending to be patient.

Despite no change in their policy, the Fed acknowledged that financial and credit conditions tightened since their last meeting as the yield curve steepened. The 10-year U.S. Treasury yield rose by more than a half point between September 20 and the end of October.

A major contributor to the increase in bond yields in recent months has been the liquidation of the Fed’s balance sheet, otherwise known as Quantitative Tightening (QT). The Fed has sold off $224 billion in Treasuries and Mortgage-Backed Securities since their July 26 meeting. Their balance sheet peaked last June and has shrunk by more than $1 trillion so far.

The last time the Fed tried to shrink the balance sheet in 2018-2019, they stopped well before selling off $1 trillion.

This time, QT is happening as the U.S. Treasury is flooding the bond market to fund the U.S. government’s deficit spending. When bond supply exceeds demand, bond prices fall, and yields rise. Hence, the Fed can leave policy words unchanged. Still, their actions are deliberately contributing to higher long-term rates, which matter more to consumers and businesses than what the Fed charges banks to borrow.

The next two Fed meetings end on December 13 and January 31. At today’s pace of QT, more than $230 billion will be sold off by the end of January. While the Fed waits to see how inflation trends, consumers and businesses may see their rates move even higher as long-term rates are pushed higher by the Treasury and the Fed’s collective dumping of supply on the market.

Since July, auto loan rates have moved up by about 50 basis points. The average new loan rate almost reached 10% in October, while the average used rate peaked just shy of 14.25%. The average mortgage rate topped 8% in October.

Since the Fed started raising short-term rates and then selling off its balance sheet last year, consumer rates on auto loans and mortgages have increased by 4.5-5 percentage points. Business borrowing costs, including the cost for dealers to carry inventory, have increased even more.

In the press conference today, Chair Jerome Powell answered a question about the pace of liquidation of its balance sheet by stating that the committee wasn’t discussing any change in that pace. The implication was that short-term rate policy must be settled first.

This means we could see longer-term bond yield and consumer and business borrowing costs continue to rise at least another percentage point.

The economy has resisted a recession thus far, while the auto market has benefitted from pent-up demand. A strong labor market has enabled real wage gains for consumers over the last several months as inflation has come down from troublesome levels last year. With lower prices on new vehicles and depreciation returning to used vehicles, affordability has modestly improved despite higher rates.

However, if we do see rates rise by another 0.5-1% caused in part by continued QT, the Fed risks sending the U.S. economy into recession, resulting in job losses. Next year’s auto market depends more on that than on short-term rate policy.

Jonathan Smoke

Chief Economist

Jonathan Smoke leads Cox Automotive’s economic and industry insights team, which tracks key metrics and trends impacting both the wholesale and retail markets for vehicles informed by the proprietary data from the company’s businesses and platforms. For 28 years, Smoke has focused on translating data and trends into relevant actionable insights for the industries that represent the biggest purchases that consumers make in their lifetimes: real estate and automotive. Smoke joined Cox Automotive in 2017.