Auto prices have soared after the coronavirus shutdowns, and after two years of the worst inflationary episode in the US since the 1980s, the industry is making it clear that returning to normal will be a long, arduous journey.
In 2021 and early 2022, global shipping woes, semiconductor shortages and factory closures coincided with strong demand to drive auto prices sharply higher. Economists had hoped prices would ease as supply chains recover and the Fed’s interest rate increase discourages borrowers.
Instead, new car prices have gone up even more. Domestic automakers still produce fewer cars and focus on more profitable luxury models. Used car prices helped dampen overall inflation late last year, but rebounded in April as supply shortages collided with an increase in demand.
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Pandemic disruptions to industry are echoing through the economy, even though the emergency is officially over, and illustrate why the Fed’s battle to crush inflation could be a drawn-out one as consumers continue to spend despite higher prices.
Inflation will not be an easy way down. Blarina Orochi, chief US economist at T.V. Row Price, “There will be bumps along the way.” “There are a lot of private factors at play right now, and I think some of that has to do with post-pandemic demand.”
High car prices proved uncomfortably sticky. Used car prices have fallen, but in a more subdued–and volatile–than economists expected. And new cars have continued to climb this year as manufacturers look to maintain margins set in 2021.
“The big question now is: Will companies start competing with each other on price?” Orochi asked.
But this is a difficult question to answer, because the car market has changed dramatically. To understand the situation, it’s helpful to examine how the auto industry worked before.
“Going into the pandemic, the dynamic in the auto business was the idea that retail profitability was under constant pressure, driven by the Internet,” said Pat Ryan, CEO of CoPilot, a car shopping app that monitors prices across about 40,000 dealerships.
Automakers have produced more cars than the market demanded, offering incentives to clear inventory and compete with lower-cost imports. Dealers made their profits from volume and financing, which often led to customer complaints of excessive fees.
With the spread of the Corona virus, factories have closed. Even when they reopened, semiconductors remained scarce. Manufacturers allocated chips to their higher-priced models—trucks and SUVs—to offset lower volume with higher profits per sale. About 5 million cars that would normally have been produced were never produced, Ryan said.
Dealers got in on the action, charging thousands of dollars above the list price—especially as stimulus programs kicked in, and consumers sought to upgrade their cars or buy new ones to escape the cities. A study by economist Michael Haflin, which was published by the Bureau of Labor Statistics, found that dealers’ profit margins accounted for 35% to 62% of all new car consumption inflation from 2019 to 2022.
There were downsides to low sales volume; Dealerships also make money on service packages after years of driving cars. Overall, “It was definitely the best of times for auto dealers,” Ryan said.
However, it was the worst of times for anyone who suddenly needed a car.
That’s the position Pittsburgh native Hailey Kott found herself in this past summer. Tired of low-paying jobs on farms and restaurants, she built a home-cleaning business at $25 an hour. When her 2005 Jeep Grand Cherokee breaks down, she knows she must quickly find a replacement to haul cleaning equipment to every job and get to school, where she is pursuing a degree in counseling.
At that point, the used cars I could find were a few thousand dollars less than the cheapest new cars, so I opted for the base 2022 Toyota Corolla. Her loan payment is about $500 a month. Insurance, which has also become more expensive, is another $200. Including gas and maintenance, the cost of moving in Kot almost equals its rent, leaving nothing for savings or entertainment.
“I think the basic necessities are really the worst,” said Kot, 29. “Food has gone up a bit, but the cost of housing, health care and cars is very high.”
The car price frenzy began to abate in the second half of 2022 as more vehicles started rolling off the assembly lines. But supply has only increased gradually. Automakers, unwilling to give up the profits made available by scarcity, have begun to talk about exercising “discipline” in their production goals.
“During that two-year period, auto dealers and automakers discovered that a lower-volume, higher-priced model was actually a very profitable model,” Tom Parkin, president of the Federal Reserve Bank of Richmond, said in an interview.
“The experience of high prices and the ability to move prices broadens businessmen’s perspective regarding their choices,” he said. “It’s attractive if you can do it.”
One of the ways automakers tried to raise prices was by eliminating cheaper models, such as the Chevrolet Spark and Volkswagen Passat. In response to the federal subsidies, auto companies rolled out electric cars, but that didn’t help bring down prices; They started with luxury versions, like the $42,995 Mustang Mach E.
There were added supply restrictions. The generation of cars that is usually delayed by three years is younger than usual. Those who rented cars in the spring of 2020 have an incentive to buy them at the prices they were locked in before everything got more expensive.
What’s more, some rental car companies are aggressively restocking their fleets after starving them for several years, prompting dealership groups like Sonic Automotive to complain about earnings calls that they outpace at auctions.
“There are so many sources of used cars that have just dried up over the past few years,” said Satyan Merchant, senior vice president of financial services at TransUnion, a credit monitoring firm. “And all of this has a downstream effect.”
The Federal Reserve sharply raised interest rates to slow demand – including for cars – and to dampen price increases. But during the adjustment period, this made it more difficult for many Americans to afford to buy a car. According to TransUnion, the average monthly payment for a new car rose to $736 in the first quarter of 2023, from $585 two years earlier. The average used car price is $523 per month, up $110 over the same period.
Cars are now a forked market: Demand remains strong at the high end, with affluent buyers with excess savings from the past two years able to soak up higher interest rates or simply pay with cash. Some are only now receiving the vehicles they ordered in 2022 at inflated prices.
Vehicle competition is also fierce at the low end, since people with weak financial cushions and personal jobs can’t afford to give up transportation, which is synonymous with the car in most parts of the country. The job market has remained strong, particularly for personal jobs in areas like hospitality and healthcare, so more people have workplaces they can access.
And many people in between, who might swap cars every few years, are waiting for prices to drop.
“What we’ve seen is the middle disappearing,” said Scott Kunz, chief operating officer of Dealer Group Midwest. It faults automakers for abandoning the cheaper, smaller, base cars that people just need to get around, especially as interest rates put the most desirable versions out of reach. “It makes no sense to me at all.”
The situation may begin to resolve itself soon. Wholesale car prices are starting to fall, and automakers are offering more incentives. Kelley Blue Book data shows average prices have fallen below list over the past two months, which Jonathan Smoak, chief economist for Cox Automotive, said indicates demand is waning. Prices have fallen in recent months for electric cars – the fastest growing segment of new car sales, although a small part of the overall market.
However, recent history has shown that pricing paths are rarely linear. In the short to medium term, more inventory was the only solution, said Adam Jonas, an auto industry analyst with Morgan Stanley.
“Despite statements from the Japanese and Koreans that the chip shortage is ending, it takes several months to adjust,” he said. “Traders should prepare for a tight summer.”
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