The Fed Is on Cruise Control. I Hope We Make It to June.

The Fed left interest rates and overall monetary policy unchanged today. We have now had five straight meetings with no change in rate policy. The Fed is effectively on cruise control, leaving rate policy restrictive and continuing to sell off assets on the balance sheet until “…inflation is moving sustainably toward 2 percent.”

Their rate projections released today, or the “dot plots,” suggest three quarter-point cuts by the end of the year. That’s the destination the Fed has provided, but the journey to get there is less clear. The Fed has official stops along the way – rate meetings – and the first cut would likely be June 12, as the next possible exit ramp is July 31, and that’s probably too long to wait.

Macroeconomic data show that inflation has ticked higher to start 2024, while leading indicators such as retail sales suggest slowing growth. That’s the balance the Fed has to seek in terms of its dual mandate to achieve price stability and full employment. And until we get there, we are stuck in this car. No sleep ‘til Brooklyn, as the Beastie Boys say.

This year’s uptick in inflation has led to higher bond yields. Bond yields moved down from recent highs today, with the Fed leaving plans unchanged despite the recent higher inflation readings, but the 10-year U.S. Treasury ended today at 4.27%, up 39 Basis Points (BPs) from the end of 2023.

The Fed’s updated projections reflect higher expectations for real GDP growth this year of 2.1% and also higher inflation, ending the year at 2.6% on the Core PCE (a key measure of prices for goods and services that excludes volatile food and energy prices). The Fed seems to believe that we are on track to get to 2.6% despite being at 2.8% today.

This forecast, combined with their rate projections, communicates that they intend to cut before achieving their target. That is appropriate since leaving rates restrictive for too long could lead to negative consequences for the economy and labor market.

Notably absent from the official statement today was the tapering of quantitative tightening (QT), which is the ongoing selloff of their balance sheet. QT pushes longer-term rates higher, not lower, all other factors being equal.

Bond yields have indeed moved higher but have also been volatile this year, with the market changing views of the potential trajectory of rates to be more aligned with the Fed outlook.

Auto loan rates have increased more in 2024 than the uptick in bond yields. The average new auto loan interest rate has increased more than 50 BPs this year, bringing the rate to 9.7% so far in March and leaving the rate up 80 BPs year over year. The average new rate peaked just below 10% in mid-October 2023. The average used auto loan rate has declined a quarter of a point so far in March to 14.3% from a 24-year peak of 14.6% in February, leaving average rates currently up 30 BPs year over year.

High rates clearly limit who can buy expensive goods like vehicles that require financing. Consumers could see rates fall by as much as a percentage point by the end of the year as the Fed cuts rate policy and as yield spreads narrow from very wide levels.

However, this presents a problem for the auto market and the broader economy in the short term. Once the impact of tax refund season ebbs in a few weeks, consumers who finance purchases may decide to stay on the roadside and wait until rates begin coming down. That could potentially slow an already slow-growing auto market.

At this point, we are stuck on this road trip. The Fed is cruising and the doors are locked. I hope we can make it to that June exit and a rate cut is waiting for us there. Otherwise, this is going to be a long, uncomfortable journey. In the meantime, I expect supply to continue to exceed demand, delivering lower new and used vehicle prices. That should help with the disinflation that the Fed needs to tap the brakes on this road trip and start cutting rates.

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.