The U.S. economy should avoid a recession over the next two years, though economic growth is expected to be modest as consumers deal with high interest rates and, for many, dwindling saving account balances.

University of Michigan economists see an increasing likelihood of an economic soft landing, noting a resilient labor market in spite of those sharply higher interest rates in their annual U.S. Economic Outlook report, released Thursday at the university’s 71st annual Economic Outlook Conference.

To be sure, they say it’s a challenging economy to interpret, much less predict, with an unexpected third third-quarter rocket ride in the form of nearly 5% economic growth—the strongest in nearly two years—fueled by a consumer spending spree despite falling slow disposable income growth.

“The economic news has surprised to the upside recently,” said Gabriel Ehrlich, director of the forecasting unit, the Research Seminar in Quantitative Economics. “We place more stock in the rapid decline in core inflation than in the third quarter growth bonanza. If the recent disinflation persists as we expect, it will allow the Federal Reserve to switch gears to a less restrictive monetary policy.”

Still, economic uncertainty remains high.

“Neither additional disinflation nor continued resilience of real economic activity is guaranteed,” said Yinuo Zhang, a senior economist at RSQE.

Another puzzle for the economists has been to what extent the Fed’s monetary tightening has contributed to disinflation, considering the persistence of growth and the labor market’s strength. If supply chain normalization and an increase in labor supply have been the major driving forces of disinflation, they say, more monetary policy action may be required to go the last mile on inflation.

This policy uncertainty could be what’s been driving long-term interest rates higher recently, economists said. They believe, however, the Fed’s contribution has been significant, and expect interest rates to start moderating soon.

“We believe the Fed has reached the terminal rate for this tightening cycle and envision the first rate cut late in 2024. We expect most medium- and long-term interest rates to stabilize in the near term and to start declining gradually beginning in mid-2024,” said Daniil Manaenkov, U.S. forecasting lead at RSQE.

The economists expect real gross domestic product—the inflation-adjusted value of everything produced in a country—will expand by 2.4% this year, 1.7% next year and 2% in 2025. The jobless rate also is expected to inch up during the period and inflation continues to moderate, allowing the Fed to start relaxing monetary policy in the form of rate cuts in late 2024.

Several recent “soft” economic data series based on surveys of consumers and businesses offer insights that seem at odds with the positive signs in the overall economy: U-M’s Consumer Sentiment Index saw encouraging signs this summer only to slide again this fall; the National Association of Home Builders’ Housing Market Index had improved over the summer, but slid back into signaling a contraction in recent months; and the Institute for Supply Management’s Purchasing Manager Indices have had recent readings consistent with slowing business activity—possibly a reflection of the United Auto Workers’ strikes against the Detroit automakers.

On the plus side, the six-month outlook surveys conducted by some regional Federal Reserve Banks suggest a gradually improving manufacturing outlook. Additionally, most “hard” economic data continue to show resilience in the face of punishing interest rates.

Of particular interest to manufacturing-heavy Michigan, the pace of light-vehicle sales is expected to slowly recover from October’s 15.5 million-unit pace to 16.2 million in the second half of 2024. The predicted slow pace will be driven in part by high vehicle loan interest rates. With falling interest rates expected later next year, the forecast calls for vehicle sales to reach 16.5 million in 2025.

On a related front, the broader economic fallout from the recent UAW strikes could have been far more severe were it not for a generally strong economy, the limited number of targeted plants and the strikes’ relatively short duration, according to the Michigan Economic Outlook. If the tentative agreements are ratified as expected, the signing bonuses and higher wages should more than offset the lost income of the state’s affected workers.

The U-M economists expect the fallout from the strikes and a cooling economy will increase the state’s jobless rate from 3.9% in September to 4.1% in the fourth quarter. They expect the unemployment rate to tick up further to 4.2% in early 2024 and stay there for about a year, then drop slightly to 4.1% later in 2025, when they foresee stronger national growth.

Michigan’s real disposable income per capita, which surged by 8.2% in 2020 because of low inflation and federal financial aid, declined by 9% last year. The forecast calls for real disposable income to tread water until the last half of 2024 before returning to growth of 1% in 2025.

As part of an effort to make its forecasts more accessible to the public, U-M’s economic forecasting team has been making their forecast reports available to the public for free online since 2022. It’s also working with university librarians to assess the feasibility of digitizing and opening access to its archives going back to the 1950s.