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Fed Reserve Raises Interest Rates

December 14, 2017

WASHINGTON, D.C. — The Federal Reserve approval of a 0.25% interest rate hike during its Federal Open Market Committee (FOMC) meeting on Wednesday could result in new-vehicle sales dropping to 16.6 million units in 2018, according to one industry analyst.

Cox Automotive Chief Economist Jonathan Smoke said higher borrowing costs, growing competition from off-lease vehicles and lower production levels will cause the market to decline modestly compared to 2017, despite expectations that economic conditions will remain favorable next year. He noted the Fed’s three rate hikes in 2017 have resulted in higher lease payments and few new leases compared to 2016.

“We are already seeing the impact of higher rates and tighter credit on auto sales …” Smoke said. “The average interest rate on new-vehicle loans, however, has only increased by 20 basis points, resulting in only a $12 increase to the average monthly payment. For lower credit borrowers, though, the increase has been far more substantial, rising by nearly a full percentage over the last year."

Seven members of the FOMC voted to approve raising the federal funds rate from a target range of 1% to 1.25% to 1.25% to 1.5%, with two members opposing the proposal.

During her press conference to announce the hike, FOMC Chair Janet L. Yellen said inflation on a 12-month basis has continued to run below 2% — the rate that the FOMC finds consistent in fostering optimal employment and price stability. While increased gasoline prices also drove up consumer price inflation following hurricanes Harvey and Irma, Yellen noted that "inflation for items other than food and energy has remained surprisingly subdued.”

"As these transitory factors fade, I anticipate that inflation will stabilize around 2% over the medium term," Yellen said. She noted that economic growth has risen since the first quarter, with the annual rate growing to 1.25%. In the second and third quarter, U.S. inflation-adjusted gross domestic product increased at a 3% pace.

"I expect that, with gradual adjustments in the stance of monetary policy, the economy will continue to expand and the job market will strengthen somewhat further, supporting faster growth in wages and incomes," Yellen said. "Although asset valuations are high by historical standards, overall vulnerabilities in the financial sector appear moderate, as the banking system is well capitalized and broad measures of leverage and credit growth remain contained."

Job gains averaged around 170,000 per month since the beginning of the year, a lower rate than last year. However, the unemployment rate has fallen to 4.1% from 4.7% since the beginning of the year, a rate that is almost six percentage points lower than the peak unemployment rate in 2010. Wage growth has remained "modest," Yellen noted.

While the rate hike isn’t expected to derail the automotive retail market, Cox Automotive Senior Economist Charlie Chesbrough said increasing rates will eventually impact vehicle sales. According to Experian Automotive, the average interest rate for a new-vehicle loan in the third quarter increased 39 basis points to 5.10%, while the average rate for used increased 22 basis points to 8.72%. The Fed Reserve previously approved quarter-point increases in June, March, and in December 2016.

"Consumers could face slightly higher costs for all their borrowing — credit card balances, student loans, financing a house or a car," Chesbrough said. "At the same time, higher rates drive up the cost to provide low-rate financing, which eats into profit margins and hurts the carmakers as well."

Smoke added: “The monthly payment matters. When rates rise, many consumers do not have an option to pay more. We believe higher rates have already led the automotive market to see some shift away from new and into used.”

Cox Automotive predicts at least three rate hikes in 2018, while the Fed forecasts three additional rate increases in 2018 and 2019.

"We continue to expect that gradual increases in the federal funds rate will be appropriate to sustain a healthy labor market and stabilize inflation around the FOMC's 2% objective," says Yellen. “That expectation is based on the view that the current level of the federal funds rate remains somewhat below its neutral level — that is, the rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel.”

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