The Federal Reserve building in Washington manages to make headlines while doing very little. As usual, the headlines that followed the central bank’s vote last month to maintain its benchmark rate mostly focused on credit cards and mortgages. However, there is something missing from that framing. Walking through a late spring car lot, past the rows of unsold crossovers baking in the sun and past the finance manager’s glass office where the real margins reside, makes it clear that no sector of the economy is as affected by a Fed pause as auto financing.
This is what sets a car apart from nearly every other major purchase. A house is able to wait. When borrowing is costly, people put off purchasing homes for years, renting for a little while longer, and waiting for interest rates to drop. A car cannot wait in the same manner. Engines break down. A new loan at a rate you would never have chosen is suddenly the wise financial decision when repair costs on an old sedan start to rise. Dealers I’ve talked to over the years seem to believe that this is the cruel part—buyers aren’t really choosing high rates, but rather being forced into them.
Furthermore, the cost of that money is crucial because over 80% of new cars are purchased with borrowed funds. A larger portion of each monthly payment is allocated to interest rather than the car itself when the Fed holds. For this reason, loan terms have increased to sixty and seventy-two months, and occasionally even longer. Extending the term makes the payment more manageable, but it leaves buyers in a precarious situation for years, owing more than the car is worth. In the same way that seven-year warranties were once commonplace, it’s possible that the industry has simply normalized this. Even so, it’s difficult to ignore how subtly the load has increased.
The same issue is carried by dealers in different forms, and it hardly ever makes the evening news. They use floorplan financing, or short-term loans secured by inventory, to borrow a lot of money in order to stock a lot. Every day, interest is paid on every car that remains unsold. Costs never go down when the Fed is stable. thin margins. Decisions about inventory become hesitant, cautious, and take longer than they should.
Another wrinkle is worth considering. Automakers relied on zero-percent promotional financing to move metal when interest rates were close to zero, and consumers grew accustomed to it. When the Fed continues to borrow at a high cost, that tool essentially vanishes. There is just not enough space for the lender. Years ago, Tesla overcame skepticism by telling a story that went beyond its balance sheet. However, most dealers don’t have a story to tell; instead, they have a payment, and at the moment, the payment is the issue.
As you watch this develop, you get the impression that a dealership and a brokerage interpret the Fed’s pause very differently. By year’s end, investors appear to be expecting a cut or two. Perhaps. Powell continues to choose patience, the labor market appears stable, and inflation is declining but unyielding. It’s unclear if the auto industry will lose a whole selling season as a result of that patience. It is evident that standing still is never truly neutral for an industry based on monthly payments and depreciating steel.