This Is the Fed Under Pressure

The Fed left rates unchanged as expected, but their assessment of economic trends and inflation took a notable downward shift compared to their “patient” view just six weeks ago. As a result of changing data and mixed concerns, the committee split on their views for future rate policy direction.

Back then the Federal Open Market Committee acknowledged that economic growth and job growth had slowed as they downgraded their forecast for real GDP growth in 2019 to 2.1%, and their forecast for inflation was cut as well, but they thought that the weak inflation condition was transitory. Now their view of economic growth is unchanged, but they are coming to terms with inflation being muted and well under their target. They lowered their inflation forecast to 1.5%.

With that weaker view of inflation, they have shifted from expecting no rate increases this year and only one next year to quite a range of possibilities: 1 committee member expects 1 cut, 7 committee members expect 2 cuts, 8 expect rates to remain on hold, and 1 member still clings to the idea of a hike in 2019.

The Fed’s view now is a far cry from where we were in December when their view was so optimistic that they were expecting two more rate increases in 2019.

The futures market now sees the odds of at least one short-term rate cut this year as a near certainty. Meanwhile, longer-term rates are already diving. However, the consumer doesn’t seem to be responding by buying big ticket items.

It sounds like we should take Guns-n-Roses’ “Patience” off the playlist and replace it with Queen and David Bowie’s “Under Pressure.” Long-term rates are under pressure by the rapidly slowing global economy as a result of ongoing trade tensions while Fed Chair Jerome Powell is under pressure from POTUS.

The irony this time is that lower rates may not help boost consumer spending.

Pray tomorrow gets me higher

Pressure on people, people on streets.

Long-term bond rates are already well-off multi-year highs reached last fall just before the peak of the Fed’s tightening campaign. The U.S. 10-Year Treasury yield fell to 2.04% after the Fed’s announcement. Global yields are driving long-term rates lower regardless of what the Fed is doing with short term rates in the U.S. The European Central Bank communicated earlier this week that further rate cuts were on the table. Yields are already negative in some countries. The U.S. 10-Year is down 120 basis points from a high of 3.24% last November.

Some consumer loan rates have fallen similarly. For example, the average 30-year mortgage rate according to Bankrate.com was 3.95% yesterday, down from a peak of 4.82% last November.

Those lower mortgage rates are boosting refinance activity, but we’ve yet to see a shift in sales of existing homes, which are down from last year and well below the level of activity when rates were last this low.

Ironically, we have not seen similar declines in auto loan rates. The average “advertised” new auto loan rate according to Bankrate.com was 4.87% yesterday, slightly higher than its level last November. We are seeing rates on actual auto loans trending higher in June. Actual new loan rates had temporarily drifted a bit lower in May as more low APR offers were available. But that seems to have reversed at least so far in June. Month-to-date on Dealertrack we see the average rate on a new auto loan at 6.54%, up 23 basis points over May. The average used rate is up 12 basis points from May to 9.96%.

How could this be? Credit is tightening for auto loans as lenders demand a higher risk spread. That tightening is offsetting the downward movement in market rates, so the consumer is not seeing better rates.

When the yield curve is inverted, lenders are incented to reduce risk, which doesn’t lower real payments.

Combine higher rates with higher sticker prices, less discounting, and lower incentives and it is easy to understand why retail new-vehicle sales are down 4% so far this year.

It is even worse for subprime borrowers. So far in June, the average rate on a subprime new vehicle loan is 17.93%, up more than a full point from May and more than 130 basis points from a year ago. This is why the action we are seeing in subprime year to date is in used financing and in leasing.

The Fed often cuts rates before a recession begins, but by the time they do, it is too late to have a stimulating effect. We may be at that point in this cycle. Is this our last dance? This is ourselves under pressure.