Federal Reserve Bank Chair Ben Bernanke has recently been giving comments that suggest that the economy might soon be witnessing a tightened monetary policy. And it has been a common saying, that given that the weight of the economic world is on his shoulders, when Ben Bernanke hiccups, the stock market hiccups with him.
Meanwhile, the U.S. auto industry has lately been flying. After some lower-than-anticipated sales figures for the month of March and April, the industry displayed a solid rebound in May, which suggests that the industry is set to show some record high number in 2013.
One of the reasons of rising auto sales has been availability of cheap credit. This may not remain the same in case of rising interest rates. The question to be asked is: What will be the impact of a tightened monetary policy on auto sales and hence on the performance of auto companies?
Is Fed tightening really a headwind for Auto companies?
Fed tightening may have no near-term impact on US auto sales but could be a headwind to the auto stocks.
With the prospect of Fed tightening via tapering looming at some point in the future, investors have been wary of the future of auto companies. To examine the impact, the historic relation between the fed funds rate (in the past the mechanism for Fed tightening), U.S. light vehicle sales figures and the relative performance of auto stocks were analyzed. It was found out that the rising interest rates have only a modest impact on the overall auto sales.
However, headwinds do arise for automotive companies in a rising interest rate environment, especially for the Original Equipment Manufacturers (OEMs), the companies which make car parts.
Rising interest rates on monthly auto loan payments is de minimis.
It is interesting to note that rising interest rates are expected to have no to minimal impact on monthly loan payments. Using a $25,000 illustrative car as an example, for every 100 basis point (1%) increase in the interest rate the monthly payment (currently $548 on a 2.5%, 48 month loan) would increase by about $11 – not overwhelming by any means.
Is there any correlation between interest rates and auto sales?
The Seasonally Adjusted Annual Rate (SAAR) figure can increase in the initial year of tightening, even though there is only modest correlation between rising interest rates and overall auto sales.
Many readers get confused between the actual sales and the SAAR figure. While the actual sales figure shows us the actual amount of vehicles (in units) that have been sold in a particular month, the SAAR figure depicts the selling rate of vehicles for a particular month. By this I mean that a SAAR rate of 15 million for a particular month indicates that the auto industry is on pace to sell 15 million vehicles on an annual basis, or 1.25 million per month.
Looking at key tightening cycles, U.S. SAAR generally improves over the first year after the initial tightening. In 5 of the last 6 tightening cycles, SAAR increased over the initial year, with the exception of 1986-1989. In about half the cycles, SAAR fell by the end of the tightening cycle (perhaps as the Fed eases after seeing economic conditions weaken), but in three other cycles SAAR finished higher at the end of tightening.
What about auto stocks?
Auto stocks tend to under-perform in periods of rising interest rates as investors resort to the “old playbook” of rotating out of interest-rate sensitive sectors.
In determining the impact on auto stocks, Ford Motor Company (NYSE:F) and General Motors Company (NYSE:GM) provided the largest data-set with which to work. The result was compelling – during the six previous periods of sustained monetary policy tightening, Ford Motor Company (NYSE:F) significantly under-performed the S&P each period while General Motors Company (NYSE:GM) under-performed the S&P in five of the six periods.
