After stronger-than-expected auto sales in the U.S. for the first nine months of 2023, we expect the momentum to brake modestly. We now expect flattish volumes into 2024 with sales failing to recover to prepandemic levels by year end 2025. We forecast global production will remain tightly linked to demand as automakers stay disciplined on inventory build-up, given that a pronounced downturn in the labor market in North America and the eurozone could push the global economy into a recession. The underlying macroeconomic scenario remains largely unchanged from our previous forecast (see Global Economic Outlook Q4 2023: Nearing The Rate Plateau, published Sept. 27, 2023, on RatingsDirect).

Gradually rising unemployment and the usual delayed impact of tightening monetary policy on consumers' purchasing power are key factors in our conservative outlook for U.S auto sales for the last quarter of 2023 and into 2024 (see Chart 1). This is consistent with our expectations for a very gradual recovery of global volumes in 2024 and 2025. The recovery comes as demand aligns to subpar global economic growth fueled by higher-for-longer rates ahead after pent-up demand releases from easing supply constraints. For more details, see Global Auto Sales Forecasts: The Pricing Party Is Coming To An End, published Oct. 9, 2023, on RatingsDirect.

In the first nine months of 2023, U.S. auto sales increased 14% as residual supply chain constraints eased, vehicle inventories at dealerships improved relative to mid-2022 levels, and sales to fleets resumed. The industry had been operating at near recession-level auto sales for almost three years, and a recovery over the next two years toward 16 million vehicle sales will depend on further supply chain improvements, labor availability at manufacturing plants, and most importantly, pent-up consumer demand. Our forecasts incorporate narrowing cushions at households to absorb the back-to-back macroeconomic shocks of high vehicle prices, ongoing inflation, and higher interest rates for longer. We expect the weakness of retail buyers to emerge in 2024 once the share of rental car and commercial fleets slows down after returning to pre-COVID-19 pandemic levels this year (roughly 20% of light vehicle sales).

Chart 1

Limited Upside To Most Ratings In The U.S. Auto Sector

Base-case scenario

U.S. economic data has been coming in stronger than expected, suggesting that an ever-elusive "soft landing" could occur. While we now expect the economy to expand 2.3% this year (up from 1.7% in our June forecast), we forecast growth slowing to 1.3% in 2024 and 1.4% in 2025 before converging to trend-like growth of 1.8% in 2026. We expect the unemployment rate to rise to 4.8% in 2025 before reversing course toward the longer-run sustainable rate of 4.0%-4.5%. We continue to forecast core inflation finally falling closer to 2.0% by this time next year. In this scenario, we expect the Federal Reserve to cut rates more aggressively than what it has penciled in, with rates likely landing at 4.4% and 2.6% by the end of 2024 and 2025, respectively.

We do not anticipate meaningful downgrades over the next 12 months as ratings for many issuers are already below prepandemic peaks. Most companies rated 'BB' and above have increasingly focused on reducing debt and building liquidity. Given the ongoing UAW strike, credit metrics will deteriorate somewhat in the fourth quarter, but our ratings incorporate some short-term fluctuation in credit metrics.

Once production eventually resumes, we expect a reasonably quick recovery in liquidity over companies' minimum operating levels, albeit with some permanently lost earnings if stoppages extend deep into the fourth quarter. Working capital investments and cost inflation will add downside risks to a few weaker issuers, especially if internal cost reduction prospects appear limited.

We believe credit metrics will stabilize to prepandemic levels by late 2024 as most companies will look to preserve liquidity, maintain prudence on reinstating dividends and share buybacks, and limit large, debt-financed acquisitions. We expect limited margin and cash flow improvement in 2024 due to higher interest rates and pricing pressure amid potential demand volatility once supply gradually normalizes.

In our base-case scenario, we incorporate the following high-level assumptions:

• U.S. auto sales increase to 15.2 million units in 2023, stay flattish in 2024, and only modestly recover in 2025-2026, still below prepandemic levels of 16 million.
• Average new vehicle prices fall about 10% over the next 24 months and demand shifts to used from new.
• For automakers operating in North America, the combined impact of marginally higher production volumes, high pricing, and lower commodity costs could offset most other cost inflation in 2023. For 2024 and beyond, despite ongoing cost reduction efforts, we do not assume a material recovery in overall profit margins or cash flows given pricing and product mix pressures amid tougher macroeconomic conditions, higher costs related to EVs, and higher costs associated with negotiating a new contract with the UAW union in the fourth quarter.
• In anticipation of tough labor negotiations, our current base case for EBITDA margins in 2024 and beyond already incorporates wage increases that would affect margins on average for General Motors Co. (GM) and Ford Motor Co. by 20 basis points (bps) to 40 bps annually. To the extent there are material changes post-contract finalization, we will reassess the impact on future earnings, cost flexibility, and ultimately on the rating outlook. For more details, please refer to Credit FAQ: How Will The United Auto Workers Strike Impact Ratings In The U.S. Auto Sector?, published Sept. 15, 2023, on RatingsDirect.
• The industry will exercise discipline while rebuilding capacity toward its revised inventory targets, which will be roughly 30% below prepandemic levels. This will ensure reduced pressure on automakers to raise incentives and lower prices, hence protecting their margins somewhat, even if consumer demand weakens over the next 18 months.
• Suppliers' margins and free cash flow will continue to improve going forward as raw material and freight inflation remain more moderate, volumes improve, and less supply chain uncertainty decreases operating volatility at original equipment manufacturer (OEM) customers. However, labor availability and wage inflation along with overall higher energy prices limit margin upside.
• Higher research and development, capital expenditure (capex), and working capital in the form of tooling to support the launch of new products geared to support EVs. While there is the potential for greater revenue opportunities from newer electrification-related products, initially this transition will be a drag on supplier margins and free cash flow. The impact on credit quality will depend on each suppliers' product portfolio and how they navigate the product transition.

Chart 2

Chart 3

With Increased Pricing Pressure, Inventory Management Will Be Critical

New vehicle prices remain about 30% above prepandemic levels in the U.S. so far in 2023 (average transaction prices of over $45,000 in August per J.D. Power). However, we expect about a 10% decline over the next 24 months in the U.S. as used vehicle prices fall (with a potentially higher supply) and consumers opt for lower-trim versions and more entry-level segments.

We believe volatility in automakers' sales (see Table 1 ) could persist over the next few months, especially because of the differences in inventory levels at the end of the third quarter across automakers. We expect most automakers with products skewed toward light trucks, particularly pick-ups, to target 50-60 days of total dealer inventory on a portfolio basis (see Chart 4). That is down over 30% compared with prepandemic levels of 80-85 days (in mid-2019) for light-truck-focused automakers.

Table 1

Light-vehicle inventory totaled 2.06 million (per Wards AutoInfobank) at the end of September 2023, nearly 45% higher than a year ago. Light-vehicle inventory at dealerships reflected a 40-day supply, up from 32 days a year ago, and a prepandemic range of 60-80 days. There is some divergence across OEMS, as some companies like Stellantis and Ford have higher inventory days and the major Asian players (Toyota, Honda, Hyundai) still have very low days' supply. We believe Stellantis and Ford were probably building inventories ahead of the UAW strike. GM had maintained more conservative levels of inventory, so supply will likely get tighter for it first.

Chart 4

EV inventories have increased significantly over the last year for some of the top electric and hybrid plug-in hybrid models (Chart 5). In particular, inventories of the Jeep Wrangler plug-in, Ford's Mach E, and VW ID.4 are trending higher and have surpassed the level of their internal-combustion engine competitors. We expect this will lead to continued competition and lower EV prices.

Chart 5

We Expect Pickup Truck And CUV Segments To Remain Strong

In the first nine months of 2023, pickup truck sales increased around 15%, slightly above the overall market, which grew 14%. Historically, pickup truck demand has had a strong correlation with housing starts. With rising interest rates, we expect housing starts to remain flat for several years at 1.4 million, down significantly from 1.6 million in 2021 and 2022. While this could indicate a headwind for pickup truck sales, we expect this to be offset by pent-up demand in recent years (due to supply constraints) to replace aging pickup trucks.

The average age of vehicles in the U.S. remains at an all-time high, at about 12.5 years in 2023, with an even higher average age for pick-up trucks. This will likely support replacement demand for some older vehicles given the supply constraints during the past two years. As a result, pickups from Ford, GM, and Stellantis N.V. are likely to remain the top three selling vehicles for 2023 (table 2).

Crossover utility vehicles (CUVs) continue to gain share faster than the overall market, with sales increasing 18.6% in the first nine months of 2023, and now accounting for 47% of the total light-vehicle market. CUVs have taken share from passenger vehicles and larger CUVs have taken share from small SUVs. Within the CUV market, the middle luxury CUV has grown quickly, likely due to purchasing strength from higher income consumers and attractive product offerings within this segment (Chart 6)

Chart 6

Table 2

Potentially Tougher Financing Conditions And Weaker Used Car Prices In 2023 Adds Risk

With a shortage of new and used vehicles inflating prices, lenders are still willing to support loans of 72-84 months to attract borrowers with lower credit scores. Moreover, they're frequently offering loans that exceed the value of the vehicle. The downside risk is that it could prevent many buyers from re-entering the new car market for several years because vehicle owners who would usually trade in for a new model could end up owing more than the car is worth. We believe subprime borrowers are delaying purchases of vehicles for now as higher borrowing costs and inflationary pressures affect their overall spending.

From a historical perspective, total subprime auto lending hasn't returned to pre-Great Recession levels. Subprime loans as a percentage of all U.S. auto loans increased modestly to 16.7% in the second quarter of 2023 after representing an all-time low of 15.3% in the first quarter, but it's still lower than 17%-19% observed in 2009 after the Great Recession.

Auto loan delinquencies (over 90 days) have risen throughout 2023, especially among younger buyers. Notably, captive debt is predominantly owned by prime borrowers and has performed relatively well. Superprime borrowers (with credit scores greater than 760) accounted for nearly 36% of all U.S. auto loan originations, the highest since early 2011 and a significant improvement from an average of about 22% in 2006 and 2007 (chart 7).

Chart 7

We expect used vehicle prices to fall 4%-5% in 2023 as increasingly difficult financing terms weigh on demand despite a limited supply of used vehicles and persistently high new vehicle prices. Recently, Carmax (the nation's largest used car retailer) reported a second-quarter comparable store sales decline of 9% due to inflationary pressures, higher interest rates, tighter lending standards, and weak consumer confidence.

Early Signs Of Slowing Momentum In U.S. EV Demand Leads To A Slight Downward Revision In Our 2025 Base Case

In the past quarter, we have seen a slight slowdown in market share gains for EVs with rising inventories for several models. As a result, we expect automakers to take a more measured approach on volume build-out in 2024 to avoid pricing wars with incumbents for upcoming launches.

With manufacturer subsidies from the IRA, investments in local supply chains, and tax credits, we still expect significant launches at more affordable price points through 2025. Together, we believe these factors will help bridge the volume gap with Europe and China. In our view, both GM and Ford have adequately invested in EV architecture and vertical integration (including securing battery capacity). However, a higher-than-expected adoption rate for EVs would likely dampen profitability and cash flow in 2023-2025, especially if it cannibalizes the market share of their legacy high-margin internal combustion engine trucks. For more on our views on electrification, see Credit FAQ: How Will The Electric Revolution Impact The Credit Quality For The Global Auto Industry?, published Oct. 20, 2022, on RatingsDirect.

Our estimate for the combined market share for EVs and plug-in hybrids is about 10% for 2023 and about 18% by 2025. This compares with a combined market share of EV and plug-in hybrids of about 9% in the first nine months of 2023, up from 6.4% for the same period in 2022.

Prices remain quite high for EVs but are falling given recent price cuts, such as the ones from Tesla (see Tear Sheet: Tesla Inc. Charges Forward With Solid Ratings Cushion Despite Margin Headwinds , published July 21, 2023, on RatingsDirect). According to Cox Automotive, the average EV price was $53,376 in September 2023, down from about $66,000 as of the end of 2022. Battery prices could fall modestly over the next year after hitting highs in 2022 as lithium, nickel, and cobalt prices have fallen 20%-60% in the first eight months of 2023. Raw materials contribute at least 70%-80% of the total cost of EV batteries.

However, significant cost reduction will depend on more lithium refining capacity coming online. Ongoing investments in global capacity, partnerships, and vertical integration will enable automakers to launch affordably priced models and improve profitability within this segment in the next three years. For new entrants and start-ups, the slumping stock market and rising interest rates will persist and make it tough to raise fresh capital from investors.

Beyond 2025, we expect lower battery costs, significant model launches, and regulatory proposals the Environmental Protection Agency announced in April 2023, which could tighten emission standards each year between 2027 and 2032, will increase EV affordability. These factors will likely help bridge the EV volume gap with Europe and China as new model launches challenge incumbents across all segments (see Charts 8 and Table 3).

Chart 8

Table 3

Related Research

• China Auto: Soft Demand Heightens Competition, Oct. 10, 2023
• Global Auto Sales Forecasts: The Pricing Party Is Coming To An End, Oct. 9, 2023
• Global Economic Outlook Q4 2023: Nearing The Rate Plateau, Sept. 27, 2023
• Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted, Sept. 25, 2023
• Credit FAQ: How Will The United Auto Workers Strike Impact Ratings In The U.S. Auto Sector?, Sept. 15, 2023
• Credit FAQ: U.S. Auto Dealers Navigate New Roads, July 20, 2023
• Industry Top Trends Update North America: Autos, July 18, 2023
• An Impending Electric Shock For Japanese Autos?, May 17, 2023
• Despite Higher Volumes, U.S. Auto Sector Ratings Upside Remains Limited Due To Macro Uncertainty, Pricing Pressure, And High Interest Rates, April 24, 2023
• Industry Risks And The Effect Of EBITDA Stress On Aftermarket Auto Suppliers, April 20, 2023
• Credit FAQ: How Will The Electric Revolution Impact The Credit Quality For The Global Auto Industry?, Oct. 20, 2022