Pent-up vehicle demand could offset loss of shoppers as interest rates rise

Enough pent-up demand for vehicles exists to offset any potential customers whom dealerships would lose with rising interest rates, some industry experts say.

"There is a terrific amount of demand still in the system," Ally CFO Jennifer LaClair said on an earnings call last month.

The lender estimated 4 million to 5 million potential buyers were stuck on the sidelines because "they cannot find a vehicle to purchase."

Ally dealer financial services President Doug Timmerman told Automotive News on April 15 the "huge" demand was more than enough to counterbalance the hypothetical 10 percent of buyers leaving the market. For this reason, Ally was "very bullish," he said.

Timmerman's assessment came about three weeks before the Federal Reserve on May 4 increased the federal funds rate 0.5 percentage point to between 0.75 percent and 1 percent. The Fed's rate increases and decreases can trickle down to influence consumer interest rates.

However, Ally had anticipated Fed rate increases this year. In April, the lender told investors its performance estimates in 2022 and beyond assume a federal funds rate reaching between 2.5 and 3 percent.

Timmerman said last month that conversations with dealers demonstrated confidence in consumer demand, even in an environment of rising interest rates.

"It's a different time," he said.

Interest rate increases would affect demand, he said. But not enough to matter.

"Pent-up demand is so large that there's going to be a consumer interested in every vehicle that will be available," Timmerman said.

Ally expects new-vehicle loan originations will remain strong this year and in the future, LaClair said. And both Edmunds and Cox Automotive forecasters believe the Fed's rate increase on May 4 probably won't have a negative impact on the new-vehicle market.

"Historically, interest rate hikes haven't affected the new-car market with any major significance because auto manufacturers are known to offer many loan subsidies," Jessica Caldwell, executive director of insights with Edmunds, said in a May 4 statement. "Even though this is the biggest rate hike we've seen in two decades, the continued inventory shortage coupled with strong demand likely means the impact of rising interest rates will be minimal on this market, as the new-vehicle buyer base of higher-income shoppers won't feel the pain as much as the average consumer."

Cox Chief Economist Jonathan Smoke agreed that the Fed's actions probably wouldn't change new-vehicle sales.

"As a result, the new-vehicle market is likely to remain inflationary as supply remains very tight and is not likely to improve substantially before 2023," Smoke said.

Pent-up demand for new vehicles remains healthy, Smoke said May 13.

"We think the market will sell about the same number of new vehicles regardless of the exact path of rates — assuming it does not get worse than what the Fed is projecting," Smoke said in a statement.

Low supply has limited the new-vehicle market to 1 million sales per month, Smoke added. Demand would remain at that level even if a recession occurred, he said.

But Caldwell and Smoke differ on the potential for higher interest rates to affect used-vehicle demand.

"We can expect a more significant ripple effect on the used side, where more buyers pay market rates that are generally not subsidized," Caldwell said in a statement. "With used-car prices already at record highs, the interest rate hike will only make this market more expensive. Some buyers will be forced to sit out entirely or buy an older vehicle to keep payments within an affordable range."

However, overall used-vehicle demand wouldn't change, according to Caldwell. She said on May 13 that other buyers would step in to fill the void as rising interest rates push consumers to older vehicle segments.

"People are just shifting," Caldwell said.

She also said a lack of supply would continue to keep used-vehicle prices elevated and protected from a plunge.

But Smoke said the used-vehicle market is cooling and higher interest rates could soften it further.

"We are seeing evidence of slowing demand, even with supply fairly normal (by days' supply measure)," Smoke wrote in a statement. "The higher rates [and] worsening financial conditions for lower-income households paint a different picture in used than in new. We think used demand is softening."

New-vehicle interest rates have increased about 0.7 percentage point so far this year, while average used-vehicle interest rates have grown by about 0.75 percentage point, according to Smoke.