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Smoke on Cars

Tapering Accelerates, and Rates Moving Higher in 2022

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The tightening of U.S. monetary policy is accelerating after the Fed’s eighth and final meeting in 2021. As expected, the Fed announced that tapering would accelerate and bond buying would end by March. This sets the stage for rate increases to begin soon thereafter as the economic priorities shift from a focus on job recovery to controlling inflation.

This meeting’s official statement noted improvements in the labor market as well as inflation: “Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation.” The Fed also acknowledged uncertainty related to COVID: “Risks to the economic outlook remain, including new variants from the virus.”

Just six weeks ago, tapering was expected to go through June 2022, and no plans for rate changes were formally established. Now with inflation at the highest level since 1982, the Fed is communicating that three quarter-point rate increases will likely happen in 2022, at least based on the updated rate dot plots released today.

The median Fed open market committee participant’s view now has three rate hikes in 2022 followed by three in 2023 and two more in 2024.

The financial markets have recently been projecting three rate increases in 2022.

Longer-term bond yields moved up modestly this afternoon in response. Yields are currently remaining in a range that represents the mid-point for the year. The highs for the year were back in late March and early April.

Consumer loans like auto loans and mortgages are more directly related to these longer-term yields rather than the Fed’s short-term rate policy. The 10-year yield is up less than 60 basis points year over year. However, consumer rates on auto loans have not moved up so far this year as yield spreads on auto loans have narrowed.

As spreads have narrowed to be more in line with spreads prior to the pandemic, most borrowers have seen lower rates even as bond yields have been higher year over year. The auto market has enjoyed stable and favorable credit trends all year.

This fall has seen more volatility in auto loan rates, but average auto loan rates moved slightly lower in November and have started December moving even lower to what are historic all-time lows for the average. Recent rates may indeed be the absolute lowest of the lows, as it is hard to see yield spreads staying narrow with the Fed tightening even if the 10-year does not move. The current consensus forecast for the 10-year is for an increase of 36-50 basis points from where we are today by the end of next year.

That means that consumers will likely see auto loan rates higher by at least a third of a point to potentially three-quarters of a point by the end of next year. From a historical perspective, rates would still be low and attractive. However, that would mean an end to the 2021 financing trend that helped mitigate some of the vehicle price inflation.

In the near term, it is likely that consumers will continue to see rates close to their current lows. It is when we near the end of the bond buying that consumer rates are more likely to start their move higher.

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