How much auto demand will the Fed's half-point rate cut produce?

The Federal Reserve's lowering of its benchmark rate target by 0.5 percentage points could reduce the market interest rates that Cox Automotive polling indicates are dealerships' No. 1 challenge.

But while experts said the Fed's action on Sept. 18 would draw some consumers back to the auto market, it was unclear whether a corresponding half-point drop in auto interest rates would be enough to unleash the demand dealerships want to see.

Satyan Merchant, automotive and mortgage business leader at TransUnion, said the Fed rate cut might have a "muted" near-term impact and "may take until later in 2024 or even 2025 to see interest rates as well as vehicle prices come down enough for consumer demand to materially increase."

TransUnion hadn't calculated the exact degree of rate cut needed to move the needle on demand, Merchant said in a Sept. 17 statement. "However, the more interest rates come down and vehicle prices stabilize and reduce, the greater opportunity consumers have to get into a vehicle at a more manageable monthly payment," he said.

The Fed set a federal funds rate target to 4.75 to 5 percent, down from the 5.25 to 5.5 percent range the central bank had maintained since July 2023 as an inflation-fighting measure. Changes in the central bank's benchmark rate can have a ripple effect on the interest rates lenders charge consumers.

The average new-vehicle borrower in August received a 7.1 percent interest rate and the average used-vehicle loan carried 11.3 percent interest, according to Edmunds. In February 2022, the last full month before the Fed began to raise its federal funds rate target from a basically nonexistent 0 to 0.25 percent range, the average new-vehicle loan had a 4.4 percent interest rate and the average used-vehicle loan charged 7.8 percent.

"Just with the news that they are going to cut rates, we've been seeing about a half a point decrease already," Justin Miller, finance director for Billion Auto Group of Bozeman, Mont., said the day before the Fed's announcement. "If we can get great customers into the [4 percent interest range], I think that it'll be great."

He said this 4 percent range ideal applied to loans on both new and used vehicles.

"Right now with a great customer profile, we're five and a half [percent interest] or so on perfect credit whether they buy new or used," he said.

Jessica Caldwell, Edmunds head of insights, said the rate cut probably wouldn't help a deep subprime buyer paying 20 percent or higher interest. But a struggling used-vehicle buyer "in the 7 percent range" might see relief — though high vehicle prices would still be an issue.

However, new-vehicle demand could benefit from higher incentive spending following the rate cut, Caldwell said.

"Automakers, they're going to be able to buy cheaper loans to give to consumers," she said, and this could lead them to offer consumers subsidized interest rates and leases on new models.

Caldwell said the mere existence of a rate cut might spur demand on psychological rather than financial grounds.

"I don't think it's suddenly going to make things affordable, but it feels like there is a signal there that makes this process more palatable to consumers," she said. "And I think that perception is sometimes what people need."

Other conditions besides rates also might affect customer demand.

"We, along with everyone, are hoping for at least two rate [cuts] between now and the end of the year," Sam D'Arc, COO of Zeigler Auto Group in Kalamazoo, Mich., said Aug. 13, a time when only a 0.25-point Fed cut seemed likely in September. "And we hope that those rate [cuts] spur buyers to purchase. But it's so difficult to know. There's so many things that go into that, right? Political environment and consumer sentiment and people feeling good about the world."

Cox Automotive Chief Economist Jonathan Smoke saw a more complex interaction between the Fed's actions and auto loan interest rates.

"My view of the demand is tied up with credit dynamics as much as it is interest rates," Smoke said Sept. 4, two weeks before the Fed cut rates. "And the key to the Fed cutting rates basically is reducing the amount of money people are spending on revolving credit card debt that is eating away at their buying power for other things and causing them to fall behind on auto loans. [This] makes the lenders risk-averse, which makes them charge very high yield spreads combined with their own uncertainty for how the economy is going to play out."

More rate cuts are expected. Fed officials' predictions for the central bank's benchmark range at the end of the year have a median midpoint of 4.9 percent. They expect the federal funds range at the end of 2025 to have a midpoint of 3.4 percent. Looking further out, the Fed is projecting rates will settle with a midpoint of 2.9 percent, a little bit below the range the Fed instituted in September 2022 but still higher than any prior time since early 2008.

From late 2008 to late 2015, the Fed kept its rate target at a microscopic 0 to 0.25 percent. It finally started edging rates upward to plateau at a high last decade of 2 to 2.5 percent for part of 2018 and part of 2019 before starting to cut rates again —and then knocking them back to 0 to 0.25 percent in 2020 during the COVID-19 pandemic.

Americans shouldn't expect that era of cheap money to return, Federal Reserve Chairman Jerome Powell said.

"It seems that's so far away now," Powell said during a press conference Sept. 18 following the rate announcement. "My own sense is that we're not going back to that, but honestly we're going to find out. ... It feels to me that the neutral rate is probably significantly higher than it was back then. How high is it? I just don't think we know."