Economists: Light vehicle sales predicted to slow as economy grows

DETROIT—Light vehicle sales are expected to decrease over the next couple of years as inflation increases and the unemployment rate continues to drop, according to the recent analysis of the Federal Reserve Bank of Chicago.

The Chicago Fed held its 24th annual Automotive Outlook Symposium (AOS), June 1–2, at its Detroit branch where more than 60 economists and analysts from business, academia, and government gathered.

According to the participants, the nation's economic growth is forecast to be near its long-term average this year and to strengthen somewhat in 2018. Inflation is expected to increase in 2017 and to hold steady in 2018. The unemployment rate is anticipated to dip to 4.4 percent by the end of 2017 and to remain at that rate through 2018.

Meanwhile, light vehicle sales are predicted to decrease from a record 17.5 million units in 2016 to 17.1 million units in 2017 and then to 16.9 million units in 2018.

State of the economy

During the 31 quarters following the end of the Great Recession in mid-2009, the annualized rate of real gross domestic product (GDP) growth was 2.1 percent in what is considered the long-term rate of growth for the U.S. economy, according to the Chicago Fed. This countered a typical pace of economic recovery/expansion that is "quite sharp" following a deep recession, the analysts said.

While the economy's expansion has lasted nearly eight years, signs of slack still remain in the economy. The unemployment rate moved down to 4.3 percent in May, below prominent estimates of the natural rate of unemployment (i.e., the rate that would prevail in an economy making full use of its productive resources), according to the report.

However, the labor force participation rate has fallen over the past several years somewhat below what demographic changes of an aging population can explain, the report said. The percentage of people who are working at part-time jobs but desire full-time employment is still above what it has historically averaged and the pool of unemployed workers who have been out of work for more than six months remains at levels higher than those seen since the Great Depression, according to the report.

There have been two big shocks whose effects have reverberated across the U.S. economy over the past three years, according to the symposium report:

Falling oil prices — the average price of oil, which stood at $106 per barrel in June 2014, collapsed later that year, reaching $59 per barrel in December 2014 and bottomed out in February 2016 at $31 per barrel. The decline in energy prices has had both positive and negative impacts on the U.S. economy. On the positive side, consumers, manufacturers and the transportation sector have enjoyed a substantial reduction in their energy costs. However, it has a negative impact on the domestic energy sector as the U.S. has become a significantly larger producer of energy over the past nine years.

Currency exchanges — The real value of the U.S. dollar in international exchange markets had strengthened substantially since the summer of 2014, rising nearly 22 percent through January. The higher value of the U.S. dollar against foreign currencies has had a dramatic impact on trade and the U.S. economy's growth. A strengthening dollar makes U.S.-made goods more expensive to foreign customers, thus reducing demand abroad, while making foreign-made goods less expensive to U.S. purchasers, thus increasing demand for imported products.

Inflation has increased with the slack in the economy and higher energy prices over the past year. By May, the year-over-year rate of inflation had inched up to 1.9 percent.

Economic outlook

The economy is expected to grow at a solid pace in 2017, at a GDP rate of 2.1 percent, and at a slightly faster pace in 2018, at a GDP rate of 2.3 percent. The unemployment rate is predicted to edge lower through the third quarter of 2017 and remain at a rate of 4.4 percent through the end of 2018.

Inflation is projected to increase from 1.8 percent in 2016 to 2.3 percent in 2017 and then remain at that rate in 2018, according to the report. Real personal consumption expenditures are forecast to increase 2.1 percent this year and 2.3 percent in 2018.

The pace of real business fixed investment is predicted to be 5.2 percent in 2017, but then ease to 4 percent in 2018. Due to the challenges posed by the stronger U.S. dollar, industrial production is forecast to grow at a rate of just 1.6 percent this year and 1.7 percent next year, well below its long-term growth rate, according to the Chicago Fed.

The housing sector is predicted to continue to improve with residential investment anticipated to expand at a rate of 6.3 percent in 2017 and then 3.4 percent in 2018. Housing starts are expected to increase to 1.26 million units in 2017 and 1.32 million units in 2018—still below what is viewed as their long-term trend, according to the report.

The long-term interest rate (10-year Treasury rate) is forecast to increase to 2.70 percent this year and to 3.11 percent next year. The short-term interest rate (one-year Treasury rate) is expected to increase to 1.42 percent this year and to 1.89 percent next year.

Auto sector outlook

New vehicle (passenger cars and light-, medium- and heavy-duty trucks) sales growth in the North American Free Trade Agreement (NAFTA) region (U.S., Canada and Mexico) has outpaced its real GDP growth, suggesting a modest downward correction in new vehicle sales is due, according to David Teolis, General Motors' senior manager of economic and industry forecasting, who presented an outlook for global and U.S. vehicle sales during the symposium.

Teolis said pent-up demand for new vehicles—which had been a significant stimulus for sales growth—is largely exhausted and is not anticipated to be a major driver for sales over the short term, with rising new vehicle prices posing a deterrent to sales.

He noted that an increased supply of off-lease used vehicles could push down prices of used vehicles relative to new vehicle prices. But low interest rates, low gas prices and growing household disposable income could be offsetting factors that could prop up new vehicle sales.

The prevailing risks to the U.S. auto market over the next few years include a negative correction to the U.S. stock market, trade protectionism and a strong dollar, he said.

Year-to-date sales of used vehicles have increased more than 4 percent from the previous year, driven by an increase in the availability of automotive credit, according to Charles Chesbrough, senior economist and senior director of industry insights, Cox Automotive, said during the symposium.

The low unemployment rate and the recent increases in job openings and quit rates indicate favorable labor market conditions—which generally support more vehicle sales (new and used) and low default rates on auto loans, he said.

Between 2010 and 2016, the leased share of all new vehicle registrations rose, he said, noting that leased vehicles return to dealers with lower prices than new vehicles, making them more attractive to consumers. The flood of off-lease vehicles has a negative impact on the residual values of these used autos.

According to IHS Markit's estimates, the annual volume of off-lease vehicles returning to all manufacturers will jump from about 3.1 million units in 2016 to 3.6 million in 2017 and 3.9 million in 2018. In addition, Mr. Chesbrough said the lengths of auto loan terms (for both new and used vehicles) have increased to keep monthly payments low—which implies future vehicle sales will likely be reduced.

High lease rates and long loan terms will be headwinds for all automotive sales over the next few years, he contended.

Commercial vehicles

Orders for heavy-duty trucks rose considerably since the final quarter of 2016, according to Kenny Vieth, president, Americas Commercial Transportation (ACT) Research Co. L.L.C.

The new order activity could be impacted by recent improvements in manufacturing activity and the jump in the number of oil rigs, he said.

Vieth pointed out that new heavy-duty truck orders have historically followed increases in freight volume and profits, and neither has suggested this spike in new orders should have happened, leading to speculation that the main driver of order activity has been overconfidence.

Meanwhile, the medium-duty market has seen steady incremental improvement, he noted, based on improvements in state and local government budgets and construction activity, especially for home building.

Heavy-duty truck production in North America is forecast to remain at 228,000 units in 2017 and jump to 265,000 units in 2018; while medium-duty truck production is expected to increase from 233,000 units in 2016 to 245,000 units in 2017 and then to 248,000 units in 2018, he said.