Inflation persists and car prices are a big reason

Car prices soared after coronavirus lockdowns, and two years after the worst inflation episode in the US since the 1980s, the industry shows that the return to normal will be a long and tumultuous ride.

In 2021 and early 2022, global transportation problems, semiconductor shortages and factory closures coincided with strong demand for soaring vehicle prices. Economists hoped prices could fall as supply chains healed and Federal Reserve rate hikes deter borrowers.

Instead, the prices of new cars have increased even more. Domestic automakers continue to produce fewer cars and focus on more profitable luxury models. Used car prices helped bring down overall inflation late last year, but rebounded in April as low supply collided with increased demand.

The echoes of the industry disruption caused by the pandemic are reverberating in the economy, even though the state of emergency has formally ended, and show why the Fed’s fight to quell inflation could be long as consumers continue to spend despite higher prices.

“Inflation will not be a smooth decline – 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 them have to do with post-pandemic demand.”

Increased car prices turned out to be unpleasantly sticky. Used car prices have fallen more quiet – and unstable — in fashion than economists predicted. And new cars continue to rise in price this year as manufacturers scramble to keep the margins set in 2021.

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

But this question is difficult to answer because the automotive market has changed drastically. To understand the situation, it is worth looking at how the car industry operated before.

“Going into the pandemic, the momentum in the automotive industry was that retail profitability was under constant pressure, fueled by the internet,” said Pat Ryan, CEO of CoPilot, a car buying app that monitors prices at around 40,000 dealerships.

Automakers produced more cars than the market demanded, offering incentives to remove inventories and compete with cheaper imports. Dealers profited from volume and funding, which often resulted in customer complaints about excessive fees.

As the coronavirus spreads, factories are shutting down. Even after reopening the semiconductors were still missing. Manufacturers allocated chips to their most expensive models – trucks and sports cars – compensating for fewer units with higher profits on each sale. Ryan said about five million cars that would normally have been produced were never produced.

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

Lower sales volumes had their downsides; dealers also make money on service packages many years after the cars have left the parking lot. But all in all, “these were certainly the best times for car dealers,” Ryan said.

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

Hailey Cote of Pittsburgh found herself in that situation last summer. Tired of low-paying jobs on farms and restaurants, she started a house cleaning business for $25 an hour. When her 2005 Jeep Grand Cherokee broke down, she knew she had to find a replacement quickly to haul cleaning equipment to every job and get to school where she was studying counseling.

At this point, the used cars she could find were only a few thousand dollars cheaper than the cheapest new cars, so she opted for a base model 2022 Toyota Corolla. Her loan repayment is about $500 a month. Insurance, which has also become more expensive, is another $200. Including gas and maintenance, Mrs. Cote’s transportation costs are nearly equal to her rent, leaving nothing for savings or recreation.

“I think basic needs are really the worst,” said Cote, 29. “Food has gone up a bit, but the cost of housing, healthcare and cars is pretty brutal.”

The car price frenzy began to subside in the second half of 2022, as more and more vehicles started rolling off the assembly lines. But the supply only increased gradually. Automakers, unwilling to give up the profits of the scarcity, started talking about “discipline” in their production targets.

“During that two-year period, car dealers and automakers discovered that the 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.

“The experience of higher prices and the ability to change prices broaden the outlook of business people in terms of the options available,” he said. “It’s attractive if you can do it.”

One of the ways automakers tried to raise prices was to get rid of cheaper models like the Chevrolet Spark and Volkswagen Passat. In response to federal subsidies, automakers introduced electric vehicles, but that didn’t help drive prices down — they started with luxury versions like the $42,995 Mustang Mach-E.

Added supply constraints. The generation of cars that usually come out of three-year leases is smaller than usual. Those who leased cars in spring 2020 have an incentive to buy them at prices that were locked in before everything went up.

Moreover, some car rental companies are aggressively replenishing their fleets after several years of famine, leading dealer groups like Sonic Automotive complain about salary talks that they are losing at auctions.

“There are so many sources of used vehicles that have just dried up in the last few years,” said Satyan Merchant, senior vice president of financial services at TransUnion, a credit monitoring company. “And it all has an end result.”

The Fed is sharply raising interest rates to slow down demand – including for cars – and cool price growth. But during the adjustment period, it makes it even harder for many Americans to afford 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. Used cars average $523 per month, up $110 over the same period.

Cars are now a forked market: Demand remains strong in the high-end segment, where affluent buyers also excess savings over the last two years are able to absorb higher interest rates or simply pay in cash. Some are only now receiving the vehicles they ordered in 2022 at inflated prices.

Competition for vehicles is also fierce at the grassroots level, as people with little financial cushion and personal work can’t afford to give up transportation, which in most of the country is synonymous with the car. The labor market remains strong, especially for personal work in fields such as hospitality and healthcare, so more people have jobs to get into.

And many people in between, who may switch cars every few years, are waiting for prices to drop.

“What we’ve seen is the center disappear,” said Scott Kunes, chief operating officer of the dealership’s Midwest. He blames automakers for abandoning cheaper, smaller, entry-level cars that people just need to get around, especially as interest rates make fancier versions out of reach. “It doesn’t make sense to me at all.”

Soon the situation may begin to resolve itself. They have wholesale car prices started to falland car manufacturers offer more incentives. Kelley Blue Book data shows that average prices have fallen below price levels over the last two months, which Jonathan Smoke, chief economist at Cox Automotive, said, signals that demand is weakening. In recent months, the prices of electric cars, the fastest-growing segment of new car sales, have fallen, although they represent a small part of the overall market.

However, recent history has shown that price trajectories are rarely linear. Adam Jonas, an auto industry analyst at Morgan Stanley, said that in the short to medium term the only answer was to increase inventories.

“Although the Japanese and Koreans say that the shortage of chips is ending, it takes many months to buffer it,” he said. “Dealers should prepare for a tough summer.”

Jack Ewing contributed to the report.

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