Summary
- Falling used car prices are driving deflation.
- However, new cars have become unaffordable for many Americans, which has increased the demand for used cars.
- The relationship between used and new car prices has stabilized well above pandemic levels.
- The low inventory/sales ratio suggests an increase in new and therefore used car prices, in line with the recent decline and increase in Manheim auction prices.
Market implications
- Greater risk of higher terminal FFR, beyond recent market price increases.
Deflation has been limited to used car prices
FOMC participants have repeatedly announced that disinflation has begun. However, disinflation has so far been limited to core goods (Chart 1). Basic services and housing prices continue to grow at pace.
Also, within commodities, used car prices have driven deflation (Chart 2). The price of other goods has continued to grow.
The Manheim auction heralds the end of deflation
CPI used car prices are calculated using JD Power data, adjusted for vehicle depreciation. In practice, the CPI used car price index tends to follow the Manheim auction prices with a few months lag (Chart 3). The two series have recently diverged, however, with Manheim auction prices falling and rising while used car prices continue to fall.
I think this time around, used car prices are also likely to follow Manheim auction prices (i.e. go down and start going up). This is largely due to the worsening affordability of new cars.
New cars are becoming more affordable for many Americans
News headlines about a “new car affordability crisis” are becoming more frequent. Since 2021, the average price paid for cars and trucks has increased by 12 and 8 ppt of disposable income per capita, respectively (Chart 4: Americans buy 3.5 times more trucks than cars). In contrast, in the previous 10 years, car and truck prices had fallen steadily relative to incomes.
The size of auto loans also shows worsening affordability: growing in absolute value and relative to per capita income, although declining relative to average car prices paid off (Chart 5).
New and used car prices will remain higher than before the pandemic
The car affordability crisis suggests a long-term increase in demand for used cars, relative to new ones. In turn, this suggests a higher ratio between used and new car prices than before the pandemic. The relationship between used car prices and average prices paid has stabilized since the second half of 2022 (Chart 6).
Conversely, the relationship between used car prices and the new car price index has been falling. This is because the BEA uses hedonic adjustments (i.e. lowers car prices to account for increased quality).
Real new car prices paid are more likely to rise than fall as the inventory/sales ratio is below pre-pandemic levels (Chart 7). In addition, manufacturers are increasing their offer of electric vehicles, which are more expensive than cars with an internal combustion engine. Rising prices paid for new cars and a stable relationship between used car prices and new cars imply an increase in used car prices, as suggested by the latest results from the Manheim auction.
Consequences of the market
Over the past two weeks, FFR 2023 market prices have caught up with the December SEP FOMC meeting. However, recent data suggests an increase in terminal FFR in the March SEP and a risk of a 50bp increase.
The analysis above suggests that used car prices could start to rise/stop falling in the coming months. This would end the price of goods and the general deflation of the core. In turn, this would strengthen the hawkish case at the FOMC and increase the risk of further hikes, which are not priced in by the market.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. He has worked in EM and DM at hedge funds, sell-side, the New York Fed, the IMF and the World Bank. Publishes the Macro Six blog that discusses the drivers of macro returns.
Photo credit: depositphotos.com
(The commentary contained in the above article does not constitute an offer or solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any decision investment or other decision. Any investment decision should be based on professional advice that is appropriate and specific to your needs.)
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