Fed Pivots: With a Big Cut, the Journey to Stronger Retail Demand Begins

The Federal Reserve changed their tune dramatically today from their stance at the last official meeting on July 31 by cutting the Fed Funds Rate by 50 basis points, double the consensus expectation of a 25-basis-point cut. This was the first official rate policy move in more than a year – the first move down since March 2020 – and begins the process of moving rates down from a restrictive level that has caused retail vehicle demand to remain below potential.

The Fed has officially pivoted to focus on a deteriorating labor market instead of solely focusing on achieving their 2% target on core PCE, which stood at 2.5% in July, the latest reading.

The wait for a change in official rate policy is finally over, but now – unfortunately – consumers will have to wait to see lower rates in auto loans. The Fed does not directly control the rates consumers see, and auto loan rates may end up being the slowest to move.

Consumers should see more immediate changes in the rates charged on credit cards, which should help improve the financial status of consumers who have built up balances to maintain spending.

This cut will be a positive change that will eventually help bring auto loan rates down. Interest expense on credit cards has been crowding out spending on goods and services and has likely contributed to delinquencies and defaults on credit cards and auto loans. With rate declines starting, this negative pressure should decline and start a more virtuous cycle for consumer credit.

As accumulating credit card interest expense declines and record balances retreat, consumer attitudes, credit performance, and spending should all improve.

Mortgage rates have already seen substantial improvement as bond yields have fallen in anticipation of the Fed starting to cut. Now that the Fed is cutting aggressively, mortgage rates should drop even more. The average 30-year rate has already fallen about a percentage point from the peak earlier this year.

Lower rates should stimulate housing demand, and an improvement in housing will also lead to stronger vehicle demand. Construction professionals and contractors make up an important segment for commercial vehicle demand. Consumers who move are also far more likely to buy a new vehicle after changing residences. More people moving means more people buying cars.

It may take several weeks or even months for consumers waiting on lower auto loan rates to see any meaningful change. With auto loan performance still shaky, lenders will be reluctant to reduce the spreads they charge to compensate for risk. That means that auto loan rates are likely to be sticky on the way down. However, with the financial performance of consumers improving from lower rates on credit cards, auto loan performance should improve as well.

As proof of that stickiness, average auto loan rates have drifted slightly higher in September, while longer-term bond yields and mortgage rates have declined. The average new auto loan interest rate so far in September has averaged 9.63%, and the average used auto loan rate has averaged 13.95%.

However, we have reached a critical point in time. With modest declines from the peaks reached earlier this year, average auto loan rates are now down year over year, but just barely. The worst is over.

The Fed’s updated dot plots expect the Fed Funds Rate to reach its median longer-term neutral rate of 2.875% in 2026, which is a decline of 2.5%, with the first 0.5% of that already in place. The average rate on new-vehicle auto loans will likely end up between 7.5% and 8% at that point, which is what we saw in 2019. The average used loan rate will likely be around 10% to 10.5%.

Rates are not headed to the lows witnessed in recent years unless a crisis forces the Fed to cut to zero again. While better for affordability, the economic conditions requiring loose monetary policy are not typically good for vehicle demand. Affordability, an issue before the pandemic, will continue to be an issue. It just won’t be as bad as it has been.

Consumers will likely see more attractive lower rates first in the new-vehicle market as manufacturers decide to subvene rates to drive consumer demand. A lower cost of capital will motivate captive finance companies in their willingness to become more aggressive. Improving auto loan performance will help even more.

Eventually, used-vehicle rates will see the most improvement as they have seen the greatest increase in average rates and widened credit spreads.

Though somewhat surprising, today’s rate decision is a step in the right direction and marks the long-awaited beginning of a stronger period for retail vehicle demand.

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.