The Fed Lowered Interest Rates Today. Unfortunately, It’s Unlikely Car Buyers Will Benefit Much.

Today’s rate cut was viewed by the market as a certainty. The Fed had ample opportunities to set different expectations, but only affirmed the market’s view at every turn. In terms of policy, what mattered more today was the amount of the July cut and the language regarding future cuts. We got a quarter cut—the first cut since 2008—and openness to cut further if circumstances warrant. The market is expecting two additional quarter-point cuts by year-end.

The bond market is already there and then some. Policy and the market do not always move in sync as we’ve clearly seen over the last 9 months. Ten-year Treasury yields peaked in November but began retreating even when the Fed raised its official policy rate one last time in December. On a daily basis, 10-year Treasuries peaked at 3.24%. They were at 2.06% yesterday, so they have since declined more than a point. Mortgage rates followed most of the decline. The bond market and longer rates like mortgage rates follow global markets, not Fed policy. In a way, the Fed is forced to cut because of what European and Asian central banks are doing.

It has been fascinating to see that as bond yields and mortgage rates moved down this year, auto loan rates did not. Average “best available” auto loan rates (as reported by Bankrate.com daily on 60-month new-vehicle loans) “peaked” at 4.84% in November. They were 4.77% yesterday but as high as 4.93% in June.

Risk aversion by lenders has kept consumer auto loan rates high even when bond rates were lower. In effect, lenders have increased the spread to compensate for perceived higher risk. When looking at real, achieved rates on auto loans, which we can view on our Dealertrack platform, we see that new auto loan average rates were up 9 basis points (BPs) to 6.36% in July from where they were when bond yields peaked in November. Used-vehicle loan average rates were down slightly by 11 BPs to 9.90%. It’s worse for subprime. Average rates on new subprime loans were 17.27% in July, up 93 BPs from November. Average rates on used subprime loans were 19.02% in July, up 37 BPs from November. Do the math on what any new-vehicle payment would look like with an interest rate above 17%.

Payment affordability has strengthened the retail used-vehicle market while weakening retail new-vehicle demand.

The rate policy was taken back to what it was in November when the Fed officially cut the short-term rate policy by a quarter point today. At the same time, the Fed ended their balance sheet drawdown two months early. Going forward, they will be reinvesting in bond purchases as loans and bonds are paid. This should remove any upward pressure on long term rates. However, these moves today do not necessarily mean consumers will see any lower rates on mortgages or auto loans.

Mortgage rates are already lower compared to last November. They may not come down more, especially if the economy seems to stabilize. But then again, those lower rates don’t seem to be spurring more home sales. The lower rates are mainly creating a boon for existing mortgage holders to refinance.

Auto loan rates have more room to decline, but that will depend on lenders’ perception of risk. It will take a few days to see if consumer loan rates respond to the Fed’s action and language today. It will take several weeks to see if lower rates lead to more demand.

We believe retail new-vehicle sales are not likely to improve this year even with moderately lower rates. Even if auto-loan rates were to come down marginally, the prospective new-vehicle buyer is still contending with the most expensive vehicles ever sold. It is likely the only way we’ll see retail demand for new vehicles strengthen substantially this year is if we see more rate subvention by the captive finance companies and higher incentives that materially lower payments.

It’s tough to predict where consumer rates will be, but given the Fed shifting policy stance from tightening to easing, the best bet is auto-loan rates will be stable to modestly lower. It takes out the risk of higher rates and therefore removes any sense of urgency to buy sooner than later.

The biggest immediate beneficiary of lower short-term interest rates in the auto industry will be dealers, as they should see an immediate reduction in the interest expenses they pay for carrying inventory and for capital for infrastructure investments. Dealers saw investment expense rise with each Fed increase last year, and they have been contending with a perfect storm of higher costs across every major expense from inventory to interest to labor. Manufacturers should benefit as well by lowering their capital cost and providing more flexibility to boost financing incentives.

The only question now: How will the Fed work through its complicated love/hate relationship, balancing the economy, an active White House and the coming election year. With a hat tip to 5 Seconds of Summer and their hit Easier, maybe in the morning they can work it out.