After the December increase, the discount rate, which the Federal Reserve controls, was up 100 basis points year over year. With this fourth quarterly increase, the Fed has increased rates more times in 2018 than any time since 2006. The last time it raised rates more was in 2005 when it increased eight times, totaling 200 basis points.
Simultaneously, the Fed has been selling off its balance sheet. The Fed’s balance sheet has grown dramatically from quantitative easing programs employed since the Great Recession. This undoing of quantitative easing, along with stronger global growth, has pushed longer-term rates like auto loan rates higher than the Fed’s policy changes over the last 12 months implied. The “best available” average advertised 60-month new-vehicle rates, as reported daily by Bankrate, are up about 120 basis points over this time last year to 4.75 percent this week. That amount of rate inflation alone would translate into 3 percent higher payments if all other variables – loan term, down payment and loan amount – remained the same.
We observe average rates that are much higher than the best available rate. In November the average new-auto loan rate on Dealertrack was 6.3 percent; the average used rate was 10 percent. This disparity reflects the distribution of credit scores in the real world. Interest rates are highly sensitive to the borrower’s credit score. Best available rates are achieved only by a borrower with a super-prime credit score.
The average new payment in Dealertrack was $567, $26 more than last November, or almost 5 percent higher. Average new-vehicle prices have increased approximately 3 percent over the last year.
After this increase, the Fed is likely to move more slowly in 2019. Their new plans and language describing the future rate direction have changed somewhat as more global economic and financial market data point some economic growth risks. And, interest rates are rapidly approaching the natural (or neutral) rate of interest, which is the interest rate that supports the economy at full employment and maximum output while keeping inflation constant. The Fed now says it is likely to increase twice in 2019 when previously they had discussed increasing three or four more times.
Auto loan rates are at a more than seven-year high. If we see rates move up by more than a quarter point, they will be in the range we saw back in early 2011 and before that 2004. The era of low auto loan rates is clearly behind us. That means that the payment becomes even more front and center to the car buying experience. Negotiating the payment is ironically the part of the buying process that consumers dislike the most and want to change.
If rates are indeed even higher in 2019, the buyer pool for new vehicles could further decline. At the same time, we are continuing to see a supply shift from more affordable sedans to more expensive pickup trucks and SUVs. Affordability will continue to be a key challenge as a result.