The End of Disinflation?

Summary

• Falling used car prices are driving disinflation.
• However, new cars have become unaffordable for many Americans, which has increased the demand for used cars.
• The ratio of used to new car prices has stabilized well above pandemic levels.
• Low inventories to sales ratio suggest more upside to new, and therefore used, car prices, in line with the recent trough and rise in Manheim auction prices.

Market Implications

• Greater risk of higher terminal FFR, beyond the recent increases in market pricing.

Disinflation Has Been Limited to Used Car Prices

FOMC participants have repeatedly been announcing that disinflation has started. Yet, disinflation so far has been limited to core goods (Chart 1). Core services and shelter prices are still growing apace.

Furthermore, within core goods, used car prices have driven disinflation (Chart 2). The price of other goods has continued to grow.

Manheim Auction Announces End of Disinflation

Used car prices in the CPI are computed using data from JD Power, adjusted for vehicle depreciation. In practice, the CPI used car price index tends to follow the Manheim auction prices with a few months of lag (Chart 3). The two series have recently diverged, though, with the Manheim auction prices troughing and rising while used car prices continue to fall.

I believe this time, used car prices are also likely to follow the Manheim auction prices (i.e., trough and start rising). This is largely due to worsening new car affordability.

New Cars Increasingly Unaffordable for Many Americans

News headlines of a ‘new car affordability crisis’ have become increasingly frequent. Since 2021, the average price paid for cars and trucks has increased by 12 and 8 ppt of per capita disposable income respectively (Chart 4 – Americans buy 3.5 times more trucks than cars). By contrast, in the previous 10 years, car and truck prices had fallen steadily relative to income.

Car loan size also shows the worsening affordability – growing in absolute value and relative to per capita income, though falling relative to average car prices paid (Chart 5).

Used/New Car Prices to Remain Higher Than Pre-Pandemic

The car affordability crisis suggests a long-term increase in the demand for used cars, relative to new ones. In turn, this suggests a higher ratio of used to new car prices than before the pandemic. The ratio of used car prices to average prices paid has stabilized since H2 2022 (Chart 6).

By contrast, the ratio of used car prices to the price index for new cars has been falling. This is because the BEA uses hedonic adjustments (i.e., it lowers car prices to account for increases in quality).

Actual new car prices paid are more likely to rise than fall, as the inventories to sales ratio is below pre-pandemic levels (Chart 7). In addition, manufacturers are increasing their EV offering, that is more expensive than internal combustion engine cars. Rising prices paid on new cars and a stable ratio of used to new car prices imply rising used car prices, just as the recent Manheim auction results suggest. 

Market Consequences

Over the past two weeks, market pricing of the 2023 FFR has caught up with the December FOMC meeting SEP. However, recent data suggests an increase in the terminal FFR in the March SEP and a risk of a 50bp hike.

The above analysis suggests used car prices could start increasing/stop falling within the next few months. This would end the goods price and overall core disinflation. In turn, this would bolster the hawkish case at the FOMC and add to the risk of further hikes, which are not priced by the market.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a 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 investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)