Auto interest rates aren't likely to climb until next year, when the Federal Reserve stops buying bonds, a Cox Automotive economist said.
The Fed had been purchasing $80 billion in Treasury bonds and $40 billion in home loans monthly. But last week, the central bank said it would purchase $10 billion fewer Treasury bonds and $5 billion fewer bundles of mortgages each month, starting in November. This practice will remain in place through at least December, when the Fed would be down to buying $60 billion in government debt and $30 billion in mortgages, but likely run longer, the Fed said.
Cox Automotive Chief Economist Jonathan Smoke said Thursday the Fed's actions indicated "rates are going to continue to be very favorable to the auto market." In fact, Smoke said he wasn't yet prepared to say auto rates had reached a floor.
The federal funds rate will remain at 0-0.25 percent until employment improves and inflation consistently exceeds 2 percent, the Fed said.
The Fed cut the federal funds rate to that level and started buying additional Treasury and mortgage bonds in March 2020 as a response to the COVID-19 pandemic.
Both the federal funds rate and the Fed's bond purchasing have a ripple effect upon auto loan interest rates, according to Warren Kornfeld, senior vice president in Moody's Financial Institutions Group.
The easier it is to borrow money or sell off loans on one's own books, the more room lenders have to finance additional vehicles at lower interest rates.
If the Fed continues to wind down buying the bonds in $10 billion and $5 billion increments, they'll be off the books by June. Smoke said bond yields probably wouldn't begin to move in a way that would affect consumer auto loan rates and dealer floorplan interest until that point or later.
A higher cost of capital for lenders carries another ramification for dealerships besides sales volume.
Subprime lenders can't permit as much of a dealer markup without bumping into state caps on interest rates, according to Nicky Dang, Moody's Structured Finance Group associate managing director.
"There's not much they can play with on APRs," Dang said.
Smoke said auto interest rates tend to follow the behavior of bond yields more closely than the federal fund rate. Tracking the difference between interest rates and yields gives a sense of how much of a premium lenders are attaching based on their perceived risk of default.
"Those spreads were much wider last year," Smoke said.
Even though the cost to borrow was low, lenders only passed on the savings to the highest-credit consumers given the uncertainty, he said. Now, better rates are spreading to other demographics.
When interest rates do finally rise, it can actually pay off for dealers with higher demand, according to Smoke. Consumers will realize the trend and want to lock in auto loans before future rate increases.
"I think you can actually look forward to a spike in demand," Smoke said.
