Credit margins shrinking in auto amid Fed rate cut, economist says
Despite the Federal Open Market Committee’s (FOMC) goal of boosting the economy and reducing the cost of borrowing money for lenders and banking institutions, the auto finance market may not see the intended benefits of Wednesday’s cut to the Federal Reserve’s benchmark interest rate, Jonathan Smoke, chief economist at Cox Automotive, told Auto Finance News.
The Fed’s second rate cut of the year brought the benchmark interest rate down 25 basis points, to 1.75% – 2.0%. Prior to July’s rate cut— which brought interest down to 2.0% – 2.25% — the Fed hadn’t cut rates since 2008.
“The question is whether or not [the rate cut] would translate to any change in [auto finance] interest rates. So far, we haven’t really seen it,” Smoke said. Specifically, subprime auto interest rates have increased since the benchmark interest rate was cut in July, he noted, adding that strong vehicle sales in August were mostly “the function of incentives and discounting rather than the rates.”
“You’re basically seeing credit tightening, and that has the effect of essentially causing consumers who don’t have the most pristine credit to have a higher risk premium, which negates what’s happening in the bond market,” Smoke argued.
Further, the Fed’s Secured Overnight Financing Rate (SOFR), which is a broad measure of the cost of borrowing cash overnight, came in at 2.55% on Wednesday night, higher than the Fed’s new target rate. “One thing you would think the Fed has absolute control over managing would be ensuring the market has a short-term rate that’s in line with their targeted rate,” Smoke said. “When this happens, its generally considered to be a reflection that there’s not enough liquidity in the market, which generally means that credit is tight or that credit is tightening as investors prioritize which short-term [investments] have the best risk-adjusted returns.”
“Even if the Fed cuts rates, if the actual market rates are higher than [the Fed’s] target rates and all of this is leaning toward lenders being more risk adverse, it doesn’t bode well,” Smoke continued, noting that the distribution of auto loans are more reflective of the U.S. population than other markets that are involved in far less subprime borrowing.
“That’s the key reason why I’m skeptical that the Fed rate cut will have any influence [on auto rates],” Smoke summarized, adding that broader market influences are more likely to affect auto rates.
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