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Smoke on Cars

Fed Holds Rate Policy Steady, But Bond Market Already Raised Actual Rates


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As expected, the Fed left rates unchanged, at least regarding the official short-term rate policy. However, they made it clear that additional rate hikes could come, as they remain “highly attentive to inflation risks.” The Fed will hold two more meetings in 2023; one on November 1 and another on December 13.

The Fed also upwardly revised economic forecasts, and their revised views of GDP and the unemployment rate imply that the Fed no longer expects a recession to occur. That is good news for the auto market. The bad news, interest rate hikes that have already occurred are putting downward pressure on the market and will do so for the foreseeable future.

The Fed has now hiked rates by 5.25% since tightening began last year to leave the Fed Funds Rate at 5.25-5.5%. That level of rate policy is more than twice the widely believed neutral rate and is the highest the policy has been since 2000. With inflation below that rate, rates are considered restrictive. With inflation expectations falling further, the current level of rate policy will become more restrictive without the Fed doing anything.

As a result, we are entering a new chapter in this monetary tightening cycle, a chapter that is less about rate increases and more about the timing of the Fed’s eventual rate reduction.

To that end, today’s biggest surprise was the revised dot plots that suggest that rates will remain at this level for longer than initially telegraphed. Rate policy is only expected to decline by 50-75 basis points (BPs) in 2024 and by another 150 BPs throughout 2025. That would leave the rate policy at the end of 2025 at 3.875%, which is a half point higher than their last forecast and higher than any policy level since 2007.

Higher rates will be one key factor that keeps affordability as a major factor that is limiting vehicle demand. The other key factor will be continued inflation in the cost of new vehicles.

The bond market has seen a marked increase in yields over the last eight weeks. The prospect of higher rates for longer, aggressive new Treasury issuances to fund deficit spending, and continued Fed downsizing of the balance sheet collectively pushed bond prices down, which causes yields to rise. The 10-year U.S. Treasury increased almost a half point from the last Fed meeting through yesterday. The 5-year increased just a little less.

Those increases are being felt in all types of consumer loans, including auto. Since July, the average new auto loan rate has increased 37 BPs to 9.58%, the highest we’ve seen for more than 20 years. The average used auto loan rate has increased 36 BPs to 13.98%, almost returning to the peak seen in March during the banking crisis.

With rates at this level, the progress made this summer on affordability could reverse course, especially since a lengthy and broad UAW strike could also challenge new-vehicle supply and because used-vehicle supply is already very tight.

The market has finished the job of crushing consumer buying power. The Fed can now pause for good on rates, as continued shrinking of the balance sheet could deliver another rate increase via bond yields.

We had expected more normal trends this fall along with rates no longer rising, but this shift higher in rates, along with a seemingly worse strike scenario unfolding before us, suggests that both demand and supply could be challenged in the final quarter of the year.

However, the fourth quarter could go up or down for vehicle sales. If the economy can navigate these challenges along with the resumption of student loan payments and a possible federal government shutdown, then we can at least go back to expecting better conditions in 2024, when used vehicles depreciate and rates start coming down, albeit only slightly.

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.

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