Jay Powell: Federal Reserve Chair, soft-landing pilot … car dealer extraordinaire?
The Fed’s big bang cut to its target interest rate heralds relief for that most important, and burdened, constituent: the US driver. Experian Plc, the credit analytics firm, reports more drivers than ever face monthly auto-loan payments of $1,000-plus. Vehicle buyers have been stretching loan repayment schedules ever further in order to keep payments manageable, according to market watcher Edmunds.com Inc. This all traces back to the inflationary pulse of 2021 and 2022, when pandemic-related disruption made new vehicles scarce and the Fed raised rates to quell prices. Drivers were paying over the odds not just for the car, but also for the money to buy it.
Using average non-bank financing rates — since bank loans represent a minority of the market — the estimated average monthly payment on a new vehicle increased from about $615 on the eve of the pandemic to $765 as of the second quarter of this year.
Buying a vehicle is just where the expenses begin. Gasoline has declined by a third since its peak in 2022 but remains higher, in nominal terms, than before the pandemic. Insurance premiums, meanwhile, have exploded, with the average full-coverage policy rising above $2,000 per year for the first time in 2023 and jumping another 13% this year, according to Bankrate.com, a data provider.
The chart below uses data (and some assumptions) for average new vehicle fuel economy, average miles driven, insurance premiums and gasoline prices to estimate the all-in cost, which went above $1,000 a month in the spring of 2022 and hit a new peak of almost $1,100 in the second quarter of this year.1 Taxes and maintenance, which aren’t here, add to the burden.
All else equal, a 50-basis-point cut takes about $9 off that, enough for one or two extra coffees a month (depending on how elaborate your tastes run). All else isn’t likely to stay equal, though, so we can expect 2025 to be better than that extra latte implies.
First, the Fed’s dot plot and consensus forecasts indicate another 150 basis points of cuts by the end of next year. If fully realized and passed into auto loan rates, that would imply a total saving on the loan of almost $40 a month relative to June.
In addition, effective vehicle prices should decline. During and immediately after the pandemic, the combination of sparse lots and pent-up demand offered dealers the rare opportunity to actually charge over the regular price, often by thousands of dollars. Normality is setting back in. Average sticker prices have topped out at just under $50,000. Moreover, the discounting ratio — the difference between a vehicle’s sticker price and what it actually sells for — has risen back up to about 3.5%. That remains below the 6% level that prevailed before the pandemic, suggesting further relief for buyers. There may be another $2,000 to $3,000 to be taken out of effective pricing, according to a recent report by Chris McNally, auto analyst at Evercore ISI.
As for gasoline, the forces pushing down crude oil prices and refining margins should persist into next year which, combined with continuing improvements in fuel economy, could knock almost $14 off the average monthly fuel bill for a new vehicle compared with the second quarter of 2024.2 Insurance premiums aren’t likely to fall; the only year out of the past 20 where auto insurance inflation went negative was in 2020. That said, the recent big jumps reflect the lagged impact of prior inflation in vehicle prices and maintenance costs, so stabilization in those suggests a decent chance that premiums will do likewise soon.
Altogether, a 200-basis-point drop in financing costs, a $2,000 decline in average effective prices and easing fuel bills could take almost $90 off the monthly cost, saving more than $1,000 per year. Assuming insurance remained flat, the all-in monthly cost could dip back below $1,000.
Besides drivers, auto manufacturers and their dealers could use the help. While they capitalized on the pricing power afforded by the pandemic’s disruption, that is unwinding and the industry needs growth. But monthly ownership and running costs that have risen to something like a small mortgage are holding sales back at around 15 million or so per year, roughly 2 million below pre-pandemic levels.
An outcome that pleases both drivers and dealers? That might be even more impressive than a soft landing.
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