Ann Arbor Times

Despite a recent and rapid cooling of the labor market, the underlying momentum in the economy remains strong—indicating a slowdown is likely in the months ahead but not one that descends into a recession, according to University of Michigan economists.

However, the researchers note that uncertainties abound, with a close presidential election, war in Ukraine and the Middle East, tensions with China, and fragility within the international financial system.

The findings come from the latest U.S. Economic Outlook released Friday by U-M’s Research Seminar in Quantitative Economics.

In the near term, economists expect both the slowing labor market and inflation to pave the way for the Federal Reserve to steadily reduce the federal funds rate range—which influences consumer interest rates—at every meeting of the Federal Open Market Committee through next spring. The pace of interest rate cuts will slow thereafter.

Expectations that the rate-cutting cycle is about to begin are already easing financial conditions, particularly with drops in the 30-year fixed mortgage rate and 5-year Treasury note yield.

Researchers say recent upticks in unemployment are concerning but not necessarily cause for alarm. The significant inflow of new immigrants has likely increased labor supply at the lower end of the wage distribution, where unemployment rates are historically higher.

The run-up is not expected to cause too much economic trouble based on robust consumer demand for goods and services and solid business fixed investment.

The forecast calls for real gross domestic product—the inflation-adjusted value of everything produced in a country—to slow from its 2.8% annualized expansion pace in Q2 this year to 2.1% and 1.3% in Q3 and Q4 respectively. Calendar-year real GDP growth registers 2.6% this year, then moderates to 1.9% in 2025 and rebounds to 2.5% in 2026.

The unemployment rate is expected to keep inching up to a peak of 4.6% by Q2 next year, then decline to 4.3% by end-2026 as monetary policy loosens.

“Although we forecast the labor market to continue cooling off through the first half of next year, we believe that the Fed’s pivot to looser monetary policy will arrive in time to forestall a recession,” said Gabriel Ehrlich, RSQE director and co-author of the U.S. forecast.

Several recent economic data series based on surveys of consumers and businesses offer a mixed picture. U-M’s Consumer Sentiment Index has been trending down from an already weak average level earlier this year. Except for a brief recovery in March, ISM’s index for manufacturing has been signaling slowing activity since November 2022. However, ISM's index for service sector bounced back in July showing moderate expansion after a weak reading in June.

Federal fiscal policy could diverge substantially depending on changes in Washington's balance of power after November elections. With middle-ground election outcome assumptions, federal budget deficit does not improve over next two years averaging 5.6%-5.7% of GDP.

Economists also assume modest import tariff increases over forecast period regardless who wins White House but add “the range of possible scenarios and their economic implications is large.”

Likewise, war in Gaza and tensions between Iran-Israel risk triggering broader Middle East conflict; forecast notes it could send shocks through global energy markets.

Overall report states U.S economy “remains noisy challenging interpret.” They envision “near-term slowdown … albeit healthy initial state.”

Forecast produced four times per year since1952 prepared by Ehrlich Jacob Burton Kyle Henson Daniil Manaenkov Niaoniao You Yinuo Zhang.

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