How will EU car stocks react to central bank easing? By Investing.com

European auto stocks may not experience an immediate boost following central bank interest rate cuts, despite hopes for increased affordability in new vehicles, Morgan Stanley pointed out in a note to clients on Wednesday. 

Historically, the sector does not react quickly to rate cuts, and weak underlying demand, combined with new and used car price deflation, typically takes time to resolve.

“Lower rates alone cannot save the auto sector,” Morgan Stanley analysts noted in their report, emphasizing that while reduced rates may help car affordability, “underlying demand can take several quarters to improve.” 

As a result, the analysts remain cautious about European auto manufacturers (OEMs) and see margin risks looming over the sector.

Morgan Stanley’s macro team forecasts that the Federal Reserve will implement its first 25-basis-point rate cut at the September Federal Open Market Committee (FOMC) meeting, bringing the policy rate down to 5.125%. 

The analysts expect a total of three such cuts before the end of the year. However, the analysts warn that this cheaper money may not be enough to offset the pressures in the auto sector.

The report also highlights that lower rates tend to coincide with decreased average selling prices (ASPs) as OEMs move to defend their market share. 

This may help improve affordability but could present a challenging margin environment. “We already reflect lower rates in our new car affordability estimates, helping but not fully resolving industry pressures,” the report noted.

Furthermore, the study shows that OEMs, as credit-sensitive stocks, may not benefit from falling bond yields as much as expected. 

“Lower bond yields, although helpful for affordability, can be the consequence of lower aggregate demand and are not always associated with tighter spreads,” Morgan Stanley said, while also pointing out that “more bullish would be signs of reflation in China.”

Morgan Stanley’s data also shows that European car stocks underperform when yields drop rapidly. “Autos’ relative performance averages -7% in months when 10Y bond yields fall over 50bps,” the report noted, indicating that rising bond yields have historically been more supportive for the sector. 

As such, the analysts suggest that for investors with a multi-year horizon, the sector’s risk-reward profile remains poor.

“We continue to think margin downgrades make the risk-reward in the sector quite poor,” the report stated, warning that the current weak demand environment and high margin estimates still pose risks for European carmakers.

Despite the pressure on OEMs, Morgan Stanley’s analysis also touched on the role of inflation. The auto sector had previously benefited from rising prices, but “recent data highlight that the fundamental backdrop for automotive pricing is now deteriorating,” with new car price inflation in the U.S. turning negative and dealer incentives rising.

“We see affordability as still stretched,” Morgan Stanley said, citing weaker underlying new car demand at current prices. The report also noted that Bayerische Motoren Werke AG (WA:)’s recent profit warning, which pointed to weak demand, especially in China, as a key factor affecting margins.