The Fed Remains Accommodative On Call That Inflation Is Transitory

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

Minimal changes were made in the official statement compared to the prior statement. While acknowledging progress on vaccinations has reduced the effects of the public health crisis on the economy, the Fed is focusing on achieving maximum employment and seeing inflation at 2% over the longer run. That means until we see the unemployment rate back where it was pre-pandemic, the Fed is expecting higher inflation, especially in the near term. 

Indeed, the latest forecast for inflation reflects a significant upgrade to inflation to 3.4% for the year from 2.4% previously.

With the conviction that inflationary pressures are transitory, 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 latest forecasts saw upgrades to expectations for inflation and GDP. The Personal Consumption Expenditures (PCE) Index is now forecast to grow 3.4% in 2021 while real GDP is expected to grow 7%. 

Last June, Chairman Jerome Powell famously said, “We’re not even thinking about thinking about raising rates.” Now the Fed is clearly thinking more about when rate increases begin, but it still looks far 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 7 now see the possibility of a rate increase next year. 

Longer-term Treasury yields had moved higher this year as the U.S. moved forward with more aggressive fiscal spending under the new administration and with the progress on COVID-19 vaccinations leading to improving economic growth expectations. However, bond yields peaked at the end of March and have moderated since, reaching new lows for the year last week. Rates moved higher today with this shift in expectations by the Fed.

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 was up about 66 basis points during Chairman Powell’s press conference compared to the end of last year.

However, consumer rates on auto loans have not moved up so far this year as yield spreads on auto loans have narrowed. In other words, consumers have seen less movement in rates and, in some cases, improvement in rates that contrasts with the upward movement of the 10-year. This is a result of lenders being willing to accept lower yield spreads with strong loan performance and record vehicle values. In fact, subprime borrowers have seen much lower rates this spring than at any point in 2020.

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 all types of auto loans.

Average auto loan rates have moved in different directions by credit tier so far in June, but average rates for most credit tiers continue to be lower than a year ago. The Fed is not changing monetary policy in the near term, so trends in the economy and in the auto market will have more of an impact on the rates consumers see on auto loans this summer. Even with bond yield and mortgage rates higher than the absolute lows last year, auto loan rates are not moving higher for every consumer. Some rates, especially for subprime, have been much lower this spring, and that has contributed to the very strong retail market.