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Smoke on Cars

The Fed Signals End of Tightening Era

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As expected, the Fed left interest rates and overall monetary policy unchanged yesterday. We have now had four straight meetings with no change in rate policy. The biggest changes from the Fed are in the language that describes their bias, which has shifted from leaning heavily towards tightening to starting to consider loosening. Rate cuts? Not yet, but that could change in just a few months.

Macroeconomic data show that inflation has eased further while the U.S. economy has slowed but remains relatively strong. This situation has led to higher bond yields since the December meeting. With lower inflation and higher yields, real, or inflation-adjusted rates are at levels that are considered restrictive and could risk future economic growth. Yesterday’s Fed announcement led bond yields down to close to where they were at the end of December.

The Fed’s new language has shifted away from discussion of further increases in rates to when they can “dial back policy restraint.” Notably absent from the official statement was the tapering of quantitative tightening, which is the ongoing selloff of their balance sheet. Instead, Fed Chair Jerome Powell indicated they would have an “in-depth discussion of the conditions for tapering QT [quantitative tightening] at the March meeting.”

With today’s decline of 11 basis points (BPs), the 10-year U.S. Treasury yield is back to within 3 BPs of where it was at the end of December after increasing 20 BPs to a 2024 peak last week.

The key question now is the timing of the first cut, and Chair Powell doubted that it could be in March. However, the decision will depend on inflation data points between now and the next policy decision on March 20.

Auto loan rates increased last month following the uptick in bond yields. The average new auto loan interest rate increased more than 50 BPs to 9.7% in late January, leaving it up 130 BPs year over year. The average new rate peaked just below 10% in mid-October. The average used auto loan rate increased more than 30 BPs to 14.1% in late January, leaving it up 120 BPs year over year. The average used rate peaked at 14.35% in mid-November.

High rates clearly limit who can buy expensive goods that require financing. High rates also impact businesses like dealers who carry expensive inventory. Still, the auto industry, like the overall economy, has held up remarkably well through this cycle of higher rates and, indeed, is showing signs of a relatively soft landing. Margins are being squeezed, but dealers remain mostly profitable. Consumers are paying more, but sales volumes have held up. And there is good news ahead: Consumers and dealers could see rates fall by a percentage point or more before the end of the year as the Fed cuts rate policy and as yield spreads narrow from very wide levels. Combining that rate expectation with likely declines in new and used vehicle prices should improve affordability, especially in the second half of the year.

Lower vehicle prices will also help the Fed see further declines in inflation measures and prove that last year’s decrease in goods prices was not a fluke. That is a key indicator that Chairman Powell and the Fed are looking for.

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.

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