Even as interest rates rise, strong demand for new vehicles could serve as the difference between a mild and a more serve recession in 2023, according to economists at the University of Michigan.
The annual forecast from U-M’s Research Seminar in Quantitative Economics notes a mild U.S. recession is likely in store to bring down inflation,
“We expect monthly inflation to tick back up in the next few months,” the U-M economists say in their outlook. “As a result, we judge that the Fed will have to keep raising the federal funds rate through mid-2023, and it will likely take a mild recession to drive inflation down for good.”
New vehicle sales boost economy
However, a potential beacon of hope comes in the form of thee auto sector, where sales of new light vehicles might be ready to boost growth. Both sales and the pace of production have improved recently. Rising inventory-to-sales ratios should help meet pent-up demand and could curb price inflation, according to the report.
U-M’s influential forecast expects auto sales to grow from 13.9 million units in 2022 to 15.1 million units in 2023 to 15.5 million units in 2024 as inflation cools.
In Michigan, the researchers say, the backlog of demand caused by supply chain shortages during the pandemic recovery could “prove to be a silver lining as the economy cools.” Couple that with the industry’s shift to electrification, which should support near-term labor demand with investments in assembly and battery production plants, the U-M forecast notes.
If “the October surprise slowdown” in inflation proves durable, the Federal Reserve will have a chance to deliver “a soft landing.”
Still, a topsy-turvy global economy with many moving parts leaves U-M forecasting will be moments to “breathe sighs of relief” instead of consistent improvement around the world.
Interest rates won’t drop until 2024
U-M economists also expect the Fed to hold the federal funds rate flat during the second half of 2023, as inflation gradually falls and joblessness slowly rises.
By early 2024, they envision the Fed to start cutting rates again, which would help to stabilize the job market.
The U-M economists also noted the “deep shock” in the U.S. housing market — not surprising given the doubling of the 30-year fixed mortgage rate during the past year. That trend is unlikely to reverse until mortgage rates peak and existing home prices are done falling.
Other signs of worry come from Fed data that show tightening lending standards for commercial and industrial loans, as well commercial real estate development. Manufacturing activity is also in jeopardy, deterioration driven by ongoing declines of goods consumption and a significant appreciation of the dollar over 2022.
On the plus side, broad measures of labor market activity remain strong: Employment growth has been robust lately and jobless claims remain low despite layoffs being a mainstay in the headlines. Given the generally soft outlook, economists say in the report they expect job gains to slow gradually over the coming months.
“We think the current momentum in the labor market and consumption spending is strong enough to keep the economy from turning over for a few quarters,” said Daniil Manaenkov, U.S. forecast lead at U-M’s Research Seminar in Quantitative Economics.
“But as the housing market contracts, businesses turn cautious due to deteriorating economic projections, banks tighten credit further and households increase their savings, the economy’s momentum will fade.”