Financial markets have taken another ride on the Wishful Thinking About Fed Policy roller coaster over the last week. Fed Chair Jerome Powell sent the invitation to come on board with a speech he gave last Wednesday, the final day of November, at the Brookings Institute.
The speech gave markets what they wanted to hear. The key changes in messaging in the speech compared to prior messaging was a tone of optimism about the possibility of a soft landing while also acknowledging that the Fed is in a new phase of risk management where they are balancing the risk of inflation becoming entrenched against the risk of overtightening.
Notably, Powell finally acknowledged that “monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt. Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down.”
The markets rejoiced, lowering yields across the curve, and sending mortgage rates down 30 BPs. The excitement was short lived. The November employment report was stronger than expected and far stronger than what the Fed wants to see. And that was followed by yesterday’s strong report from the Institute of Supply Management that indicated strengthening conditions, including labor. These latest macro data points affirm the continuing conundrum that the Fed faces and the likelihood that they will raise rates by more than a point before they reach the end of this tightening phase.
Signs Point to Possibility of Recession in 2023
Financial markets must now view the context as leading to a recession and the Fed then cutting rates in 2023 in response. Longer yields like the 10-year have not gone back up to recent highs, yet the Fed Funds rate will be well above 4% in just over a week. As a result, we have a severely inverted yield curve that is a harbinger of bad times ahead.
Auto loan rates are not as volatile as other consumer rates like mortgage rates. Auto rates tend to move slowly and catch up with Fed and market moves over time. Where will they go if the Fed and the market are moving in different directions?
Now a few days into December, we’ve seen auto rates inch higher. As a result, used loan rates have now moved more year to date than mortgage rates.
If we have more than a point in moves by the Fed to go, we’re likely to see auto loan rates move similarly. That will mean rates will be at a more than 20-year peak by spring next year, just in time for a disappointing tax refund season. With this context, demand for auto will be challenged in the spring. This should produce the cooling the Fed wants to see in the auto sector, at least.
What’s Next? The Fed’s Last Meeting of the Year Concludes on December 14
Check back in the Newsroom for an analysis of the next verse in the economic narrative after the final Federal Reserve Open Market Committee meeting for the year concludes on Wednesday, December 14. One thing we know now: This year began with major supply issues holding back business for the auto industry. As the year ends, with signs of new-vehicle supply finally improving, a fresh set of demand challenges are on the horizon.
Jonathan Smoke is the chief economist at Cox Automotive.