The Federal Reserve is signaling that it may skip a much-rumored rate hike following its upcoming June 13-14 meeting. That would mean that the current federal funds rate of 5.0-5.25% would remain in place until at least the following meeting on July 25-26.
A decision to skip another increase to the federal interest rate would indicate that the past year-plus of aggressive interest-raising may be nearing an end. It could also signal the beginning of an end to the rapid increase in auto loan rates that has coincided with increases to the federal funds rate – and perhaps that car loan rates may be on their way down in the near future.
Auto Loan Rates Are Still Climbing
Since the first hike in the current series in March 2022, consumer auto loan interest rates have risen alongside those rate hikes. At the time of the first funds rate increase, the average interest rate on a 60-month loan was 4.52%, while the funds rate was 0.2%. In February 2023, 11 months later, the average auto loan rate had risen to 7.48%, while the funds rate had increased to 4.57% – a 65% increase to auto loan rates and a 2,185% increase to the federal rate.
The increase has been a major factor in the affordability crisis that the automotive industry has been facing over the past three years. While supply chain issues and demand have elevated the sales price of cars, the surge in auto loan rates has substantially increased the cost of borrowing money to finance those purchases.
As a result, the affordability of cars has decreased significantly over that same time period. Cox Automotive uses median weeks of income needed to purchase a new car as its primary affordability metric. Despite a slight drop (less than one percent) in the amount of weeks needed to purchase a car from March to April, the current rate of 42.9 weeks is still 4.9% higher than it was in April 2022, and nearly 27% higher than in April 2021.
The decrease in affordability is still a major challenge for the automotive industry, said Cox Automotive Chief Economist Jonathan Smoke.
“Though we are seeing some slight improvement in our index, affordability challenges are still a major barrier to the new-vehicle market,” said Smoke. “We continue to see subprime buyers squeezed out of the auto market by the Fed repeatedly moving rates higher. The 10 consecutive rate increases have limited who can buy vehicles to mostly high-income, high-credit-score buyers.”
Why the Fed May Decide To Skip a Rate Hike in June
Both officials suggested that the pause in rate hikes would allow the Fed to evaluate the nation’s current financial condition.
“Having come this far, we can afford to look at the data and the evolving outlook and make careful assessments,” said Powell.
Jefferson made similar comments in his speech, when he said that “Skipping a rate hike at a coming meeting would allow [Fed policymakers] to see more data before making decisions.”
Over the past 14 months, the Fed has implemented 10 rate hikes, pushing the funds rate to 5.0-5.25%, its highest in over 16 years. Increases to the funds rate were designed to cool the economy and temper inflation, which had exceeded 8% in 2022. While inflation has slowed since the rate hikes began, the most recent reported rate in April of 4.4% is still well short of the Fed’s stated target of 2%.
“I don’t really see a compelling reason to pause – meaning wait until you get more evidence to decide what to do,” said Mester. “I would see more of a compelling case for bringing (rates) up.”
The dissent of Mester and other officials means that a June rate hike is still possible. However, following Jefferson’s speech on May 31, speculators on Wall Street set the odds of a rate hike skip at 65% after setting the odds of a rate increase happening at 70% earlier that same day.
Would a Rate Hike Skip Mean Auto Loan Rates Will Come Down Soon?
Consumer lending rates are directly tied to the federal funds rate. As a result, the short-term future of auto loan rates depends heavily on the Fed’s decision at the June meeting.
If the Fed decides to raise the funds rate in June, increases to auto loan rates will almost certainly follow. Similarly, auto lending rates will likely remain the same if the Fed decides to skip a rate hike, at least until the July meeting.
But a rate hike skip likely won’t mean that the federal funds rate has reached its peak, or that the current cycle of increases is coming to an end – at least according to Jefferson.
“A decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle,” he said in the same speech on May 31.
That means that it’s also likely that auto loan rates have not reached their peak, even if the Fed decides to keep the federal funds rate in place. In other words, there is no indication that auto lending rates will drop any time soon.
When Will Auto Loan Rates Start to Come Down?
Economists suggest that auto lending rates aren’t likely to come down in 2023. That said, our research revealed few solid predictions relating to when the rates actually will start to come down. The best indicator of where auto loan rates are heading is the federal funds rate. When institutional borrowing rates go down, consumer lending rates will follow. However, predicting when the federal funds rate will reverse course is much more complicated.
In December 2022, policymakers at the Fed predicted that the funds rate would reach a target of 4.1% by the end of 2024. That would be a nearly 24% decrease from the current rate.
However, that prediction may not hold. Since December, inflation has risen from then 3.3% to 4.4% in April, meaning that the rate is trending in the wrong direction. Since the federal funds rate has been one of the main tools used to try and tame inflation, the Fed could choose to continue increases or hold at the current rate until inflation numbers come closer to the target.
Fed officials have been extremely clear about their goal of bringing the inflation rate under 2%. If the inflation rate reverses its current trajectory and begins to approach that number, there is a good chance that rate cuts may be on the way.
However, inflation isn’t the only concern for officials. A larger-than-expected impact from tightening credit and increased borrowing costs could also cause the Fed to consider lowering rates again to stimulate the economy.
The simplest answer to when auto loan rates will start to come down is to watch the Fed. Officials have suggested that a June rate hike skip won’t imply that rates will come down soon. But should that be the decision, it could indicate a reassessment of the current economic situation and perhaps the Fed’s strategy. If nothing else, it will mean that auto loan rates won’t go up again – at least for another month.