The Fed Not Yet Ready to Taper

U.S. monetary policy was unchanged today as the Fed issued their official statement following their fifth meeting of 2021.

Minimal changes were made in the official statement compared to the prior statement. They acknowledged progress towards the conditions necessary to eventually move away from easy monetary conditions but said they will continue to assess progress in future meetings. The Fed remains focused on achieving maximum employment and seeing average inflation at 2 percent over the longer run. While inflation has been higher than the target lately, the Fed continues to see the recent higher inflation as transitory and driven by unique reopening circumstances along with bottlenecks in supply chains that will eventually get resolved. 

With no formal change in policy, the Fed is sticking to its game plan of keeping rates at the zero-lower bound and continuing quantitative easing through their ongoing program of buying Treasury bonds and mortgage-backed securities. This meeting again had a unanimous vote on the current policy.

The likely next milestone in the Fed’s progression on monetary policy change will be the communication of a tapering strategy, which may come at the Fed’s annual Jackson Hole Symposium in late August. That strategy would define the pace of tapering and the eventual timing of rate policy increases.

Based on the June dot plots from Fed officials, rate increases look quite a way off. Of 18 officials, 13 expect at least one rate increase before the end of 2023, 11 see at least two increases by that time, and only 7 see the possibility of a rate increase next year. 

Bond yields have retreated since peaking in late March and early April as concerns about persistent inflation lessened and as global COVID cases began surging again. 

After reaching a 5-month low in yields last week, rates are only modestly higher this week and have moved only slightly higher today.

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 now up 67 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. Spreads had widened last year during the pandemic, especially for lower credit tiers.

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. Now that bond yields are retreating from their early spring highs, it is likely that consumers will continue to see low and attractive rates on auto loans. This can help to offset the impact of price increases as most vehicle purchases are financed. 

The movement in spreads is one input into our view of credit availability, which has shown that auto credit is now easier to get than a year ago across all major types of auto loans.

Average auto loan rates have fallen so far in July, so average rates for all credit tiers continue to be lower than a year ago.

The used car market will help to prove the Fed’s thesis that inflation has been transitory. With used retail prices expected to have peaked in July and starting to decline as wholesale prices have been doing for six straight weeks, a major contributor to headline inflation this spring will start to reverse.

With the Fed sticking to its current monetary policy, trends in the economy and in the auto market will continue to have more of an impact on the rates consumers see on auto loans this summer. Thus far, lower rates are helping to keep demand strong despite very tight supply conditions in the new vehicle market.