Inflation Persists and Car Prices Are a Big Reason

Inflation Persists and Car Prices Are a Big Reason

“Car prices have skyrocketed in the wake of the coronavirus lockdown, and two years into the worst episode of inflation in the United States since the 1980s, the industry is showing the return to normal will be a long and choppy road.

In 2021 and early 2022, global supply problems, a semiconductor shortage and factory closures coincided with strong demand, driving up vehicle prices significantly. Economists had hoped prices could fall as supply chains rallied and Federal Reserve rate hikes deterred borrowers.

Instead, new car prices have continued to rise. Domestic automakers are still producing fewer cars, focusing on more profitable luxury models. Used car prices helped lower headline inflation late last year but rebounded in April as tight supply collided with rising demand.

The echoes of the pandemic-related disruptions in the industry are reverberating through the economy even as the state of emergency officially ends, highlighting why the Fed’s fight to contain inflation could be protracted as consumers continued to spend despite higher prices.

“Inflation is not going to be a smooth descent — there will be bumps along the way,” said Blerina Uruci, chief US economist at T. Rowe Price. “There are so many idiosyncratic factors at play right now, and I think some of that has to do with post-pandemic demand.”

The increased car prices have proved uncomfortably persistent. Used car prices have fallen, albeit in a more muted — and volatile — mode than economists had expected. And new cars have continued to rise in price this year as manufacturers scramble to maintain the margins achieved in 2021.

“The big question now is: will companies start to compete with each other on price?” asked Ms. Uruci.

But this question is difficult to answer because the automotive market has changed drastically. To understand the situation, it is helpful to examine how the automotive industry previously functioned.

“At the start of the pandemic, the dynamic in the auto business was that the internet was constantly squeezing retail profitability,” said Pat Ryan, chief executive officer of CoPilot, an auto-shopping app that monitors prices at about 40,000 dealerships.

Automakers produced more cars than the market demanded, providing incentives to destock and compete with cheaper imports. Traders made their profits from volume and funding, which often led to customer complaints about excessive fees.

As the coronavirus spread, factories were shut down. Even with the reopening, semiconductors remained in short supply. Manufacturers allocated chips to their most expensive models — trucks and sport utility vehicles — offsetting lower volumes with higher profits on each sale. About five million cars that would normally never have been produced, Mr Ryan said.

Dealers jumped in the action, charging thousands of dollars above list price — especially as stimulus programs rolled in and consumers sought to upgrade their vehicles or buy new ones to escape the cities. A study by economist Michael Havlin, published by the Bureau of Labor Statistics, found that dealer markups accounted for 35 to 62 percent of total new vehicle consumer inflation from 2019 to 2022.

The lower sales volumes also had disadvantages. Car dealerships continue to make money from service packages years after the cars have left the parking lot. But by and large, “It was certainly the best of times for car dealers,” Mr Ryan said.

However, for anyone who suddenly needed a car, it was the worst of times.

That’s the position Pittsburgh native Hailey Cote was in last summer. After getting fed up with low-wage jobs on farms and in restaurants, she started a $25-an-hour house cleaning business. When her 2005 Jeep Grand Cherokee broke down, she knew she had to find a replacement quickly, taking the cleaning equipment to every job and to the school where she is pursuing a life coaching degree.

At the time, the used cars she could find were only a few thousand dollars cheaper than the cheapest new cars, so she settled on a base model 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, Ms. Cote’s transport costs are almost as much as her rent, leaving nothing for savings or recreation.

“I think it’s the basic needs that are really the worst,” said Ms Cote, 29. “Food prices have gone up a bit, but housing, healthcare and car costs are pretty high.”

In the second half of 2022, the car price frenzy began to ease as more vehicles rolled off the assembly line. But supply has only increased gradually. Automakers, unwilling to forego the profits of scarcity, began talking about exercising “discipline” on their production targets.

“During this biennium, auto dealers and automakers found that a low-volume, higher-priced model was actually a very profitable model,” Tom Barkin, president of the Federal Reserve Bank of Richmond, said in an interview.

“Experiencing higher prices and being able to change prices broadens business people’s perspectives on their options,” he said. “It’s attractive when you can.”

One way automakers tried to drive up prices was by phasing out cheaper models like the Chevrolet Spark and Volkswagen Passat. Automakers rolled out electric vehicles in response to government subsidies, but that didn’t help bring prices down — they started with luxury versions like the $42,995 Mustang Mach-E.

And there were delivery bottlenecks. The generation of cars that are typically rented for a period of three years is smaller than usual. Those who leased cars in spring 2020 have an incentive to buy them at the prices that were set before everything got more expensive.

In addition, some rental car companies are vigorously replenishing their fleets after several years of starvation, leading dealer groups like Sonic Automotive to complain on earnings announcements that they are losing at auctions.

“There are so many sources of used vehicles that have just dried up over the last few years,” said Satyan Merchant, senior vice president of financial services at TransUnion, a credit monitoring firm. “And it all has this downstream effect.”

The Fed has raised interest rates sharply to curb demand, including for cars, and slow price increases. But during the adjustment period, many Americans will find it even more difficult to afford a vehicle. According to TransUnion, the average monthly payment for a new car rose to $736 in the first quarter of 2023, up from $585 two years earlier. Used cars cost an average of $523 per month, up from $110 over the same period.

Cars are a divided market today: Demand remains high at the higher end of the range, where wealthy buyers with excess savings from the last two years are able to afford higher interest rates or simply pay in cash. Some are only now receiving vehicles they ordered in 2022 at inflated prices.

Competition for vehicles is fierce, even at the lower end of the range, as people with limited financial resources and personal jobs cannot afford to be without transportation, which in most parts of the country is synonymous with a car. The job market remains strong, especially for personal jobs in areas like hospitality and healthcare, allowing more people to find jobs.

And a lot of people in between, who might change cars every few years, are waiting for the prices to drop.

“What we’ve seen is the disappearance of the middle,” said Scott Kunes, chief operating officer of a Midwest retailer group. He accuses automakers of forgoing cheaper, smaller and simpler cars that people just need to get around, especially as interest rates make fancier versions unaffordable. “It doesn’t make any sense to me at all.”

The situation may soon resolve itself. Wholesale car prices are starting to fall and car manufacturers are offering more incentives. Kelley Blue Book data shows average prices have fallen below list prices over the past two months, which Jonathan Smoke, chief economist at Cox Automotive, says is a sign that demand is slowing. Electric car prices have fallen in recent months — the fastest-growing segment of new car sales, despite making up only a small part of the overall market.

However, recent history has shown that price trajectories are rarely linear. Adam Jonas, Morgan Stanley’s auto industry analyst, said that in the short to medium term, more inventory is the only answer.

“Even though the statements from the Japanese and Koreans say that the chip shortage is ending, it will take many months to recover,” he said. “Retailers should brace themselves for a tight summer.”

Jack Ewing contributed to the coverage.