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Fed Reserve Approves Third Rate Hike of 2018

September 27, 2018

FOMC Chairman Powell answers reporters' questions during Wednesday's press conference.
FOMC Chairman Powell answers reporters' questions during Wednesday's press conference.

WASHINGTON, D.C. — The Federal Reserve approved on Wednesday its third interest rate hike this year, increasing its target range for the federal funds rate a quarter percentage point to 2% to 2.5%. While expected, the increase is likely to put more pressure on the U.S. automobile business.

Citing the same factors he listed when the Fed approved its last rate hike in June, Federal Reserve Chairman Jerome Powell said Wednesday’s decision is the best way the Fed can promote an environment in which every America has the opportunity to succeed.

“Our economy is strong. Growth is running at a healthy clip. Unemployment is low, the number of people working is rising steadily, and wages are up. Inflation is low and stable,” he said. “All of these are very good signs. Of course, that’s not to say that everything is perfect. The benefits of this strong economy have not reached all Americans.”

The hike, however, will further exasperate the growing affordability problem in the auto industry. In an analysis issued shortly after the Fed’s decision, Cox Automotive Chief Economist Jonathan Smoke noted that the “best available” 60-month new-vehicle loan rates reported earlier this week by Bankrate were already up about 75 basis points compared to a year ago. That amount of inflation alone would translate into 2% higher payments, he said.

“The increase would turn a $500 loan payment into $510 a month, which may not seem significant,” Smoke said. “Over a 60-month loan, however, the price is up $600 over the same purchase last year.”

Things aren’t likely to get better for consumers or the industry, he added, noting that the seven increases over the last 22 months have already changed the market from one that had peak new-vehicle sales two years ago to one that now has peak used-vehicle sales.

The rate hike was the eighth since 2015, and the Federal Reserve isn’t done. It signaled it will raise the cost of borrowing again in December, with more hikes expected in 2019. And although Powell said the gradual return to normal is helping to sustain the strong economy “for the longer-run benefit of all Americans,” Smoke said there are limits to what consumers can afford.

“By necessity, the higher rates are forcing consumers toward vehicles that will deliver the payment that works,” he said. “As a result, the new-vehicle market is challenged by affordability, and, ironically, the most affordable and most popular vehicles are imported and face the threat of new tariffs which will drive their prices higher.”

Powell noted that household spending and business investment are expanding at a brisk pace, and the overall growth outlook remains favorable. He added that the Federal Open Market Committee’s projection for growth of real GDP is 3.1% this year and 2.5% next year.

Job gains averaged 185,000 per month over the last three months, well over the pace needed in the long run to provide jobs for new entrants to the labor force, Powell said. The unemployment rate stood at 3.9% in August and has been near that level since April.

“Smoothing through month-to-month variations, the labor force participation rate remains about where it was in late 2013 — a positive sign given that the aging of our population is putting downward pressure on participation,” Powell said. “We expect the job market to remain strong.”

He added that the FOMC’s projections for the unemployment rate this year is 3.7%, and a bit lower than that in 2019.

Overall consumer prices, as measured by the price index for personal consumption expenditures, increased 2.3% over the 12 months ending in July, while the price index, which excludes the prices of energy and food, rose 2% over the same period.

“The FOMC seeks, and expects to see, inflation remaining near our 2% longer-run objective on a sustained basis,” Powell noted. “At any given time, inflation may be somewhat above or below 2%. For example, the recent rise in oil prices has pushed inflation a little above 2%, but we expect this to be transitory, as is reflected in our projections.”

Powell added that projections for both the overall and core inflation measures remain very close to 2% across the whole projection horizon.

“Readers of the FOMC statement likely noted that the committee dropped a sentence that indicated that ‘the stance of monetary policy remains accommodative,’” Powell said. “This change does not signal a change in the likely path of policy; instead, it is a sign that policy is proceeding in line with our expectations. We still expect, as our statement says, ‘further gradual increases in the target range for the federal funds rate,’ and this expectation is reflected in the projections that I just discussed.”

For car buyers, that means prices won’t get any better, especially with higher interest rates, coupled with higher production costs from tariffs, putting upward pressure on vehicle prices, noted Charlie Chesbrough, Cox Automotive’s senior economist.

“Another rate increase is expected in December, so monthly payments are likely to follow,” he said. “In addition to rising prices and payments, inventory levels are in a better condition this year than last, leading automakers to keep incentive spending in check.

“This combination of factors is likely pricing some buyers out of the market and may be leading other shoppers to buy now rather than wait,” he added. “These buying conditions are likely to continue to deteriorate and suggest next year’s vehicle market will be under even more pressure.”

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