Rate Cuts Won’t Fix Tesla’s Deeper Problems

The Federal Reserve is widely expected to cut interest rates on Wednesday, the first time in nearly four years. With the current benchmark federal funds rate coming in at between 5.25% to 5.50%, there is significant room for the central bank to lower borrowing costs, beginning with a possible reduction of 25 to 50 basis points. The potentially long cycle of rate cuts could extend over the next several quarters. But what does this mean for Tesla (NASDAQ:TSLA), and will it solve the company’s demand problems? Also, check out our analysis of other ways to profit from the Fed’s next move?

Higher interest rates have been proved to be a headwind for the auto industry at large, and Tesla is no exception. Elon Musk has indicated that the U.S. Federal Reserve’s tight monetary policy is a key factor behind Tesla’s cooling sales, particularly in the U.S. market. With financing costs elevated, many potential car buyers have held off on making purchases. For perspective, Tesla’s overall deliveries fell about 11% year-over-year to 792,188 units in the first half of 2024, a sign that the automaker is feeling the strain of high borrowing costs. A rate cut would help make vehicle financing more affordable, reducing monthly payments and encouraging some buyers who are on the fence to move forward with their purchases. As interest rates fall, financial institutions are likely to gradually pass on lower borrowing costs to consumers, which could help stimulate demand in the auto market. For Tesla, a Fed rate cut may act as a catalyst, potentially reversing some of the downward pressure on sales.

While easing interest rates might alleviate some pressure on Tesla, we believe that the company’s challenges run deeper than the tight monetary environment. The affordability of cars remains a broader issue across the U.S. auto industry, and competition is also heating up in the electric vehicle (EV) space. While mainstream automakers typically refresh their models every seven to eight years, Tesla’s current lineup – the Model 3, Y, X, and S – has remained largely unchanged in terms of design since launch. The Model S for example, was first launched in 2012 and has only seen incremental external design updates since then.  This aging product lineup is starting to pale in comparison to newer EV offerings, particularly from competitors in China, where local manufacturers are producing a diverse range of appealing electric vehicles. Moreover, the early adopter market for EVs appears to be saturating, reducing the pool of first-time buyers. Tesla’s aggressive price cuts over the past year, aimed at spurring demand, also appear to have lost their initial impact, as price competition grows fiercer. Did you know that Tesla also has a fast-growing Clean Energy business. Could It help derisk the company’s auto business? 

Overall, the performance of TSLA stock with respect to the index over the last 3-year period has been quite volatile. Returns for the stock were 50% in 2021, -65% in 2022, and 102% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it has outperformed the S&P 500 each year over the same period.

Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment around rate cuts and multiple wars, could TSLA face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?