Car business could take brunt of impact from keeping rates high
The job market improved in April, but the Federal Reserve doesn’t like how inflation is tracking, so policymakers decided not to lower interest rates this week.
Comerica Bank is expecting rate cuts by the end of the year, but Cox Automotive chief economist Jonathan Smoke is concerned about what demand for durable goods — things like cars — will be by that point.
It’s all creating a massive economic challenge Federal Reserve chair Jerome Powell acknowledged again on Wednesday afternoon after the Federal Open Market Committee (FOMC) decided unanimously to maintain the target range for the federal funds rate at 5.25% to 5.5%.
“Although some measures of short-term inflation expectations have increased in recent months, longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets,” Powell said in his prepared statement during a news conference.
“The Fed’s monetary policy actions are guided by our mandate to promote maximum employment and stable prices for the American people. My colleagues and I are acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. We are strongly committed to returning inflation to our 2% objective,” he continued.
Before taking questions, Powell addressed what’s likely on the minds of dealerships and finance companies.
“We have stated that we do not expect it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward 2 percent,” Powell said. “So far this year, the data have not given us that greater confidence. In particular, and as I noted earlier, readings on inflation have come in above expectations. It is likely that gaining such greater confidence will take longer than previously expected. We are prepared to maintain the current target range for the federal funds rate for as long as appropriate.
“We are also prepared to respond to an unexpected weakening in the labor market,” he continued. “We know that reducing policy restraint too soon or too much could result in a reversal of the progress we have seen on inflation. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.
“In considering any adjustments to the target range for the federal funds rate, the committee will carefully assess incoming data, the evolving outlook, and the balance of risks. Policy is well positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate. We will continue to make decisions meeting by meeting,” Powell went on to say.
The next time the FOMC meets is on June 11-12.
And since Powell brought up employment, let’s touch on the April ADP National Employment Report produced by the ADP Research Institute in collaboration with the Stanford Digital Economy Lab.
ADP reported private sector employment increased by 192,000 jobs in April and annual pay was up 5.0% year-over-year.
The ADP National Employment Report is an independent measure and high-frequency view of the private-sector labor market based on actual, anonymized payroll data of more than 25 million U.S. employees.
“Hiring was broad-based in April,” ADP chief economist Nela Richardson said in a news release. “Only the information sector — telecommunications, media, and information technology — showed weakness, posting job losses and the smallest pace of pay gains since August 2021.”
Comerica Bank chief economist Bill Adams and senior economist Waran Bhahirethan think we might be throwing footballs by the time the Fed chooses to cut interest rates based on their analysis of what policymakers are doing and current economic metrics.
Adams and Bhahirethan said in their commentary, “… the Fed will likely wait until September to start reducing the fed funds rate and will likely make two quarter percentage point rate cuts by the end of 2024. That is less than seemed likely when the Fed met in March.
“Separately, the Fed will likely continue to reduce their balance sheet at the new, slower pace through the turn of the year, and eventually end balance sheet reductions in the spring of 2025,” the Comerica Bank experts added.
While economists and policymakers are discussing fall and spring, dealerships and finance companies need to retail vehicles and build strong portfolios now. Here’s what Cox Automotive’s Smoke said about that situation through his regular blog post after a Fed decision.
“Most buyers finance durable goods like autos. As a result, the monthly payment is the metric that tests affordability. Even though prices for vehicles, both new and used, have been slowly falling, the declines are not producing much relief in monthly payments because interest rates have risen,” Smoke said.
“The story of 2023 was the resilient economy that avoided recession despite aggressive tightening by the Fed. But that was last year’s news. It’s different now. Durable goods are the canary in the U.S. economy, and that canary has already run out of oxygen,” he continued.
With that bird evidently in dire straits, Smoke cautioned about a deflationary spiral, especially in the car business if potential buyers keep delaying their action in hopes of lower prices and more attracting financing rates.
“With the impact of tax refund season effectively over, the vehicle market is seeing declining sales momentum. The next few weeks and months could be challenging if consumers en masse believe they are better off waiting to purchase,” Smoke said.
“The Fed will communicate updated forecasts and rate projections at the meeting in June. Hopefully, by then, they will see better inflation progress. But they will also likely see more evidence of slowing in the economy, like is happening in durable goods. If so, we could see cuts before the end of the year … just not yet, nor any time soon,” he went on to say.