Since 2022, surging global economic inflation has been trending in the news. Inflation has touched nearly all goods and services we consume, including new and used motor vehicles, which comprise 8.1 percent of the Consumer Price Index.¹ This article examines recent developments in the automobile sector in the United States and explores how this sector is emblematic of the larger inflation story that is unfolding in the US and here in Canada.

Average new car prices have been on a steady rise for over a decade² due to factors such as increasing consumer preference for SUVs, electric vehicles, and luxury vehicles, which are generally pricier than the sedans that were previously in favour.

Since the onset of the COVID-19 pandemic, changing consumption patterns (e.g., people directing more of their spending towards durable goods), reduced public transit usage, a preference for social distancing, and low interest rates caused demand for vehicles to surge. At the same time, supply chain disruptions—and in particular, the microchip shortage—constrained supply. These conditions caused the average transaction price for new automobiles to increase by approximately 20 percent from the onset of the pandemic until the end of 2021.

With car buyers looking for price relief and access to a vehicle without a long delivery wait time, tightness in the new car market rippled into the used car market, where the average used car price skyrocketed over 40 percent during the same period in the US.

Figure 1

Source: Kulka, Chris and Ben Litwin. “Market Monitoring Insights: Examining the Potential Credit Impact of High Vehicle Costs for Consumers.” Consumer Financial Protection Bureau, September 19, 2022.  

As vehicle prices increased during this time, one silver lining for car buyers in 2020 and 2021 was that interest rates on car loans remained at historic lows. Cheap car loans and costly vehicle prices have extended the terms of car loans, with the average car loan term in the US reaching over 70 months towards the end of 2020.

Figure 2

Source: Created by author using Federal Reserve Economic Data (FRED), Federal Reserve Bank of St. Louis. 

Once the scale of inflation started to become apparent in 2022, central banks began tightening monetary policy³ to bring inflation under control. However, one year into this tightening cycle, automobile prices remain elevated.

Data from the Manheim Used Vehicle Value Index⁴ shows that while used car prices in the US are now approximately 10 percent lower than their peak in early 2022, they are still 40 percent higher than they were in the spring of 2020. New car prices, on the other hand, have seen no price relief, and average new car prices as of the end of 2022 continue to set records, despite rising interest rates. The average transaction price in the US approached $50,000 for new cars,⁵ versus approximately $27,000 for used cars.⁶ By the fourth quarter of 2022, average interest rates for new and used car loans had increased to 6.5 percent and 10 percent, respectively.⁷

High transaction prices coupled with rising interest rates have contributed to all-time-high monthly loan payments of $717 per month. Over 15 percent of new car buyers committed to monthly payments of over $1,000 per month, compared to just 6.7 percent of car buyers in the fourth quarter of 2020. 

Up until now, it has seemed that consumer demand for automobiles has been impervious to higher financing costs. Indeed, in the broader US economy,  a tight labour market and rising wages have contributed to persistently strong retail sales despite an economic slowdown.⁸ However, into 2023, there are signs that consumer demand for vehicles may be starting to run out of steam. This chart below highlights how sharply new vehicle affordability has deteriorated.⁹

Figure 3

Source: Cox Automotive. “New-Vehicle Affordability Declines Again in November, Monthly Payment Hits $762.” December 15, 2022. 

Additionally, the share of auto loans that are delinquent has surpassed levels seen during the global financial crisis,¹⁰ despite an unemployment rate that is at 53-year lows, further highlighting the strain that vehicle buyers are under.

Figure 4

Source: Ballentine, Claire. “Americans Fall Behind on Car Payments at Higher Rate Than in 2009.” Bloomberg, January 27, 2023. 

From a supply standpoint, the car microchip shortage continues to persist; however, it does look like the situation is bottoming out,¹¹ and in time, this will help ease the supply constraints that have plagued the industry. Lastly, while inventories remain tight relative to historic norms, they are up 65 percent from January 2022 to January 2023.¹² Additionally, affordable vehicles have the tightest supply, indicating that car buyers might be beginning to balk at the relentless climb in vehicle prices.                                                                                                          

In conclusion, if you’re in the market for a vehicle right now, be prepared to spend much more than you may have in the years prior to the COVID-19 pandemic. However, if you can hold off for a while, as supply constraints ease and increasing interest rates start to bite, the market may become more favourable for buyers in the coming years.