Earlier this year, the Federal Reserve predicted it would cut interest rates three times in 2024, each by a quarter point. The year is approaching the halfway point and not a single rate cut has been made yet. Yesterday, Federal Reserve Board Chairman Jerome Powell even said, “It is unlikely that the next rate hike will be an increase,” leaving the door open to that possibility.
The Federal Open Market Committee, commonly called “the Fed,” sets the interest rate on overnight loans between banks. This interest rate impacts the rest of the economy and influences the interest rates banks charge on credit cards and loans.
That rate is currently at a 23-year high – part of an attempt to curb inflation. It’s not working in all sectors of the economy – Powell told reporters yesterday that “inflation has shown a lack of further progress” towards the Fed’s goals.
Durable goods like cars are now in deflation
But Jonathan Smoke, chief economist at Cox Automotive, says it works too well for what economists call durable goods, a category that includes cars.
“According to the GDP data, the consumer durables sector is improving deflation and is already in recession,” he says. “If restrictive monetary conditions are maintained, the situation risks getting worse and potentially spilling over into other areas of the economy.”
Related: New car prices at their lowest in nearly two years
“We are no longer in 2023, when pent-up demand, excessive savings due to the pandemic and revenge spending sustained economic growth despite the Fed’s aggressive tightening. We’ve been on cruise control in restrictive territory for nine months,” he says.
Monthly payments are an affordability issue
Most Americans borrow money to buy cars. Smoke says monthly payments, not prices, are the real test of whether cars are affordable.
“Although new and used vehicle prices are slowly falling, the declines are not resulting in much relief from monthly payments as interest rates have increased.”
Related: Average used car price down 4% compared to last year
The Fed has said it aims for 2% inflation, Smoke notes. “The exact level of inflation that is ideal or tolerable is controversial. The Fed is focused on 2%, but many say 2.5% or even 3% would also be fine for the economy. And we are already in that area.”
However, inflation still occurs when it comes to other expenses – such as insurance
Prices continue to rise in other parts of the economy. Insurance costs are rising rapidly – the price of the average car insurance premium increased by 22% in just one calendar year. This causes the Fed to hold back.
The risk: When it comes to major purchases, everyone waits
However, Smoke fears that “deflation may be even scarier, and the durable goods sector has officially struggled with deflation for the past three quarters.” Both new and used car prices have been declining for two years. Initially it was a correction and return to normality, but the market is at an inflection point as consumers now expect prices to fall further.”
Related: Is now the time to buy, sell or trade in a car?
That can trigger what economists call a “deflationary spiral” — consumers waiting to make big purchasing decisions because they expect prices to fall further. If everyone watches car prices fall month after month and hears news about a possible interest rate cut, Americans will stop buying cars.
“With the impact of tax refund season virtually over, the vehicle market is witnessing declining sales momentum. The next few weeks and months could be challenging for consumers a lot “I think it’s better for them to wait to buy,” Smoke explains.
The Fed will meet again in June. He hopes they may then see signs of a rise in inflation. “But they are also likely to see more signs of a slowdown in the economy, as is the case with durable goods. If so, we could see cuts before the end of the year… just not yet and not any time soon.”