Fed Rate Increase Could Cut Vehicle Demand

The Federal Reserve is expected to raise interest rates next week, and a 0.5% increase could reduce vehicle demand by 150,000 units in a year.

That’s what J.D. Power says, basing the estimate on an econometric analysis of historical consumer behavior in response to changes in the cost of buying and financing new vehicles.

To learn how the expected rate increase may affect future purchase decisions, J.D. Power conducted a survey of 2,301 Americans.

The poll indicates that if the Federal Reserve raised interested rates by 1% (which is at the upper end of expectations):

If the Fed’s interest rate increased by 0.5%, 75% of respondents would not change their discretionary spending habits.

WardsAuto spoke with Dave Sargent, J.D. Power’s vice president-global automotive, about a rate increase’s potential effect on vehicle sales and what automakers and dealers can do about it. Here’s an edited version of the interview.

WardsAuto: Your survey says many consumers think a 0.5% increase in the Fed rate would mean a 1% increase in car-loan interest rates. Why are consumers thinking a 0.5% Fed increase would have double the impact on the marketplace?

Sargent: We didn’t particularly ask them why they thought that. My guess is they think dealers and financial institutions in general would raise the consumer rate higher than the Fed rate to raise the margin. I don’t know how well consumers really understand how these things work in practice.

WardsAuto: Is it typically the case that consumer-rate increases exceed Fed-rate increases?

Sargent: Actually it’s not. If anything, manufacturers and dealers try to protect consumers from this and to protect their sales They might subvent the rate or swallow the additional costs in order to get the consumer in the car.

WardsAuto: J.D. Power suggests tools at their disposal include reducing prices, increasing incentives and subventing rates. Is there any one that’s better than the other?

Sargent: Those are all tools in the toolbox. Another is extending the length or lease of a loan to get the monthly payment down. Most consumers are looking at the monthly payment more than the other variables.

WardsAuto: A risk of extending loans is that some people in the industry feel they are extending out too far already in some cases. But it’s definitely a way to lower monthly payments.   

Sargent: We’re seeing the loan length extending quite a bit. The concern is that the consumer is hooked to it for a long period. The question also is if they delay replacing the vehicle, although many consumers replace a vehicle halfway through the existing loan. We’re seeing 72-month auto loans make up a third of the industry right now.

WardsAuto: WardsAuto is predicting light-vehicle sales of 17.8 million next year. Based on that, 150,000 fewer unit sales is about 0.8%. So it doesn’t seem like a reason to batten down the hatches.

Sargent: Is it a lot? Not really. I think what the survey told us is some consumers will initially overreact to any increase because it has been a long time since the Fed increased rates. It will be in the news. There will be a certain “Is the sky falling in?” But for those truly in the market for a new vehicle, when they see the actual impact on their payments, it will be fairly negligible.

WardsAuto: What do you suppose would be the threshold of a Fed interest rate being high enough to freak people out?

Sargent: Hard to say. I don’t know that there’s a magic number. But people for the most part are not going to freak out at half a percent. One percent is at the very high end of people’s expectations. No one will freak out over that either, but clearly the impact would be stronger.

WardsAuto: Presumably 20% would do it.

Sargent: It might. But it seems a little unlikely. It would be very surprising even if it were 1%.

Loan rates are historically low right now. Five years ago they were higher. A 0.5% raise is not going to get us even close to where we were. The average APR on a 72-month loan for a new car is 3.3%. It was 5.3% five years ago, and higher before then.   

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