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Smoke on Cars

Fed Skips June but Keeps July Rate Increase as Likely


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The Fed did not raise rates today, which was widely expected. This was the first meeting without an increase after 10 straight increases. However, the Fed avoided calling it a pause or the end of rate increases and set a clear expectation that at least one more rate increase was likely as early as the next meeting in July.

The result of the prior 10 increases is a Fed Funds Rate at 5% on the lower bound, which is well above the widely believed neutral rate of 2.5%. This level of rates causes credit-sensitive sectors like housing and the used-car market to slow down because of the impact on affordability.

The impact on demand in auto comes through limits on who can buy vehicles when financing costs are much higher.

The challenges on demand are less apparent in the recovering new-vehicle market, where supply has limited sales over the last three years. However, the new market is likely not experiencing as much retail sales growth as it could have.

We have seen far more of an impact on the used market, where sales have declined for more than a year.

The good news for consumers is that the rates on auto loans may not worsen despite the threat of another rate increase from the Fed.

The rates consumers pay on auto loans are more tied to bond yields and yield spreads than the Fed Funds Rate, and both of those appear to have peaked earlier in the year when the banking crisis added to credit tightening. In addition, for borrowers with good credit, rates in the new market are often more attractive than the average due to subsidies provided by auto manufacturers.

The average interest rate for a new auto loan has been flirting with 9% since March but has resisted going above that level. The average new rate so far in June is 8.9%, up 2.8 percentage points from a year ago. Rates were already moving up this time last year, so the year-over-year comparison will get more attractive as the year progresses.

We have seen more pain in the used-vehicle market. The average interest rate for a used auto loan hit 14% in March, but rates have been lower since then as yield spreads narrowed from how much they had widened during the worst of the initial banking crisis days in March. The average used rate so far in June is 13.6%, up 3.3 percentage points from a year ago.

One other factor will help consumers struggling with affordability in the used market: depreciation. Wholesale price declines have accelerated this spring, which should lead to lower retail prices this summer. As rates stop increasing and prices decrease, affordable used-vehicle payments will eventually come within reach.

Even the new market will also get some help on the affordability front. While new-vehicle price inflation is still likely, as evidenced by still increasing MSRP and invoice prices, with more supply, consumers are seeing discounts grow relative to MSRP. Incentives are also up substantially year-over-year, including financing subsidies.

It is increasingly likely that we can avoid a recession this year, especially if the Fed has only one rate increase left. Consumer spending has remained robust to keep the economy growing. The vehicle market has had challenges with affordability, but if rates do not get worse, demand should stabilize and improve over the longer term.

However, rates are near a 20-year high, and according to our latest Cox Automotive Dealer Sentiment Index, automobile dealers across the industry are indicating the economy and high interest are the top factors holding back business. Prices are not likely to decline much with supply constrained in both the new and used markets. These limits on demand and supply should hold sales within a range of what we have been seeing, as neither demand nor supply is likely to change much in the coming weeks and months.

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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