How Will EU Car Stocks Respond to Central Bank Easing?

European auto stocks may not see an immediate boost from central bank interest rate cuts, despite optimism about increased affordability for new vehicles, according to a note from Morgan Stanley sent to clients on Wednesday.

Historically, the auto sector has shown a slow reaction to rate cuts. The combination of weak underlying demand and price deflation in both new and used cars typically takes time to resolve.

Morgan Stanley’s analysts remarked that “lower rates alone cannot save the auto sector,” noting that while reduced rates might enhance vehicle affordability, improvements in underlying demand could require several quarters.

Given this outlook, the analysts maintain a cautious stance on European auto manufacturers and identify potential margin risks within the sector.

Morgan Stanley’s macro team anticipates that the Federal Reserve will make its first 25-basis-point rate cut during the upcoming Federal Open Market Committee meeting in September, reducing the policy rate to 5.125%. They forecast a total of three rate cuts before the end of the year. However, the analysts caution that this more affordable capital may not sufficiently alleviate pressures within the auto industry.

The report also points out that lower rates generally coincide with falling average selling prices as manufacturers work to protect their market share. While this may enhance affordability, it could also lead to a challenging environment regarding profit margins. The report states, “We already reflect lower rates in our new car affordability estimates, helping but not fully resolving industry pressures.”

Moreover, the study indicates that manufacturers, being sensitive to credit conditions, might not gain as much from declining bond yields as anticipated. The analysts noted, “Lower bond yields, although advantageous for affordability, can result from diminished overall demand and are not always linked to tighter credit spreads.” They also mention that “more positive indicators would be signs of reflation in China.”

Morgan Stanley’s data reveals that European automotive stocks typically underperform when 10-year bond yields decrease rapidly, with their relative performance averaging -7% in months where these yields fall by over 50 basis points. Historically, increasing bond yields have been more beneficial for the sector.

As a result, the analysts advise that for investors looking at a multi-year horizon, the risk-reward ratio for the sector remains unfavorable. They caution that downgrades in margin projections contribute to this poor risk-reward outlook, particularly given the prevalent weak demand and elevated margin expectations facing European automakers.

Despite the ongoing challenges for manufacturers, the analysis also addresses the influence of inflation. The automotive sector had previously benefited from rising prices, but recent data suggests that the fundamental conditions for automotive pricing are deteriorating, with new car price inflation in the U.S. now negative and an increase in dealer incentives.

Morgan Stanley stated, “We see affordability as still stretched,” highlighting weakened demand for new cars at current price levels. The report also referenced a recent profit warning from a major automaker that cited weak demand, particularly in China, as a significant factor impacting profit margins.