The good news for the U.S. economy is that the recession may have ended as fast as it started, with a bottom likely recorded in May. The bad news is that the recovery will be slow.

As states across the U.S. begin to loosen lockdowns in an effort to bring back economic activity, the world's biggest economy has a long way to go to return to pre-pandemic heights. S&P Global Economics estimates that it will take about two years for U.S. GDP to regain its year-end 2019 level, with unemployment remaining high, consumer spending depressed, and business demand recovering only slowly.

That said, barring a second wave of COVID-19 that forces states and regions to reinstate lockdown measures (our downside scenario), we anticipate the recovery will take hold in the third quarter. Growth will be strong initially as consumer spending and business demand rebound--with consumers recovering from lockdown fatigue helped by rehiring and businesses restocking empty shelves. However, the lingering effects of the pandemic-induced crisis will severely limit the pace of growth, held down by a slow jobs recovery as stimulus fades. We now see full-year GDP contracting 5.0%, slightly better than our April forecast, followed by a modest rebound of 5.2% growth in 2021--a full percentage point weaker than our previous estimate of 6.2%.

This Sudden-Stop Recession Took A Bigger Toll Than The Great Recession

This comes as the National Bureau of Economic Research made perhaps the easiest call in its 100-year history, declaring that the U.S. entered recession in March, ending the longest expansion (128 months) in the country's history. On the bright side, our expectation that the recovery has already begun means that this would also be the shortest recession on record, briefer than the six-month downturn that ended in July 1980. As it stands, we expect third-quarter GDP to grow 22.2%. A nice bounce, but don't be fooled by the double-digit gains. It will take two years before GDP levels reach their previous fourth-quarter 2019 peak.

The longest U.S. economic expansion on record burned out at an astonishing pace, with the sharpest contraction in economic activity since World War II. The sudden-stop recession has likely lopped off a massive 11% from economic activity--almost three times the decline of the 2008-2009 recession and in one-third of the time. The federal government's economic relief package and the Federal Reserve's stimulus measures will likely help conditions, but not enough to offset the drag on second-quarter economic activity.

The contraction in GDP showed up in first-quarter figures, with a 5% annualized contraction, and is set to worsen substantially in the April to June period. Business fixed investment in the first quarter pulled back by 7.9%, its largest pullback since the Great Recession. Trade volumes also collapsed, and consumer spending fell by 6.8%, its biggest drop since 1981. Consumer spending on durable goods in the first quarter was down 13.2% over the quarter, the biggest drop since the fourth quarter of 2008. It will be much worse in the second quarter, likely 4.0x the first-quarter rate. Spending on nondurable services was down 9.7% in the first quarter--a historical decline--and is likely to show a larger drop in the second quarter.

The first-quarter GDP decline was the sharpest drop since 2008. But it will be no match for the expected 33.6% (annualized) contraction in the second quarter.

The power of the pandemic's economic damage rang loud and clear in April's numbers. Companies cut capital spending dramatically to preserve cash, with durable goods orders plunging more than 17%. Energy-related investment also collapsed as oil prices dropped sharply. Excluding the more volatile categories, core capital goods orders, a leading indicator for business investment, dropped the most in more than 10 years, pointing to a collapse in business investment of 41.7% (annualized) in the second quarter. Reflecting the dire outlook for investment was a record 11.2% tumble in industrial activity--the worst reading in the century-long history of the data.

Despite higher unemployment benefits and one-off checks to households prompting a 12.9% bump in personal disposable income, consumer spending fell a record 13.6% in April, reflecting shut-ins and precautionary behavior. Higher income and lower spending meant that the personal savings rate jumped to 33%. We expect the savings rate to decline as economic activity restarts and lockdown fatigue sets in--seen in the 17.7% jump in May retail sales. But, the still-fragile jobs market also means that the savings rate will drop again after the fiscal aid expires, falling to 9.3% in the fourth quarter.

Many Downside Risks To The Recovery

The recovery will continue to face headwinds as fears of another wave of COVID-19 will likely keep Americans maintaining some form of social distancing, opting for at-home dinners and movie nights rather than restaurant and theater visits. Businesses that survive the two to three months of lost revenue may also be reluctant to quickly rehire all their workers as they clean up their books.

Most states slowly relaxed social distancing restrictions, on the belief (or hope) that the virus was contained and on the need to restart an extremely weak economy. However, the containment is fragile, with spikes seen in parts of the U.S. Indeed, a premature reopening of the economy may also mean that the curtailment of COVID-19 will be slower. Even if lawmakers want to go back to business as usual, fearful consumers may decide to self-quarantine, discouraging them from resuming past spending habits, keeping a robust economic rebound at bay.

The economic damage associated with the COVID-19 pandemic is nonlinear. If the containment takes twice as long as expected, for example, the economic damage will be more than twice as bad as the length of the recession, with recovery longer and weaker (with more lost output). And, even if the spread of the virus were to end tomorrow, the effects could linger, especially if social distancing becomes a new normal or business and consumer spending doesn't bounce back as people await the arrival of a vaccine.

Table 1

After Historic Losses, A Fast Recovery Is Not In The Cards

Market talk has turned to what the shape of the recovery will be, using varying letters--V, U, W, or the dreaded L. Before jumping to a label (people may have different descriptions of what makes a "V" or a "U"), it may be useful to see the shape for yourself. Chart 2 compares the level of GDP in our June baseline and downside forecasts with the prerecession path in December. (See "Downside forecast" for more.)

Chart 1

Chart 2

The second-quarter plunge in GDP is shocking, especially since it came after the expansion path was relatively benign, with no signs of significant threats to the expansion in the near future. It's reasonable to expect a quick recovery after the states open their economies. Indeed, we expect that the recent bounce in retail sales was partly driven by more spending options after businesses opened, but also by lockdown fatigue after months of quarantine.

However, several factors will likely keep a check on how fast the recovery is. Foremost, when an effective vaccine will be readily available in the U.S. remains a limiting factor. We currently assume a due date sometime in the second half of next year, limiting any near-term economic recovery as households likely play it safe. A cautious spending stance will also likely keep businesses (those that survived the quarantine) reluctant to rehire laid off workers. Now that small businesses that received Paycheck Protection Program (PPP) loans need to only rehire 60% of their precrisis workforce, they have even more incentive to stay on the sidelines until the coast is clear.

As Federal Reserve Chair Jerome Powell said in his biannual testimony to Congress, "there are something like 25 million people who have been dislodged from their jobs either in full or in part due to the pandemic." Even with the May jobs liftoff, 19.6 million jobs have been lost since the virus. We expect that many of these jobs that fell victim to COVID-19 will never return as the businesses that survive reduce their staff. While new jobs will be created, we expect that it will take time to regain all those jobs lost as the economy adjusts to the new post-virus economy. Moreover, the fiscal support to households, such as student loan payment deferment (for six months) and federal unemployment benefits of $600 (set to end July 31), will likely expire in the near future if Congress doesn't extend them.

With those factors in mind, we don't expect GDP to reach its precrisis level (fourth-quarter 2019) until fourth-quarter 2021. The unemployment rate will not get back to precrisis levels until at least the end of 2023. In a rather soft jobs market this year and next, consumer spending will remain sluggish, not enough to offset the crash during the recession, with spending down 4.8% for the year.

Business investment will likely be held back by both the less-than-stellar domestic spending and the sluggish international conditions capped off by heightened trade tensions between the U.S. and China. With world energy demand low for the foreseeable future, together with supply dynamics, oil prices will remain below breakeven for U.S. energy companies, particularly U.S. shale. That will keep energy-related investment at a standstill. With the exception of intellectual property, business investment is expected to be down sharply in 2020, with only a modest gain the following year.

The 1990 and 2001 recoveries got back to their prerecession expansion paths at a faster pace. However, the Great Recession significantly drifted off its prerecession course. Now there is increasing worry that the same may be true for the sudden-stop recession in 2020 (see "COVID-19 Deals A Larger, Longer Hit To Global GDP," April 17, 2020).

With little to no productivity gains expected later on, it will take about two years for the recovery to reach precrisis levels. But we don't expect the new expansion to catch up to the pace of economic activity that the U.S. enjoyed during expansions before the Great Recession. One suboptimal path of recovery, and what is currently our U.S. baseline forecast, is that the economy could shift to a lower parallel path. While the growth of labor, capital, and productivity remains unchanged from pre-COVID-19, the level of one or more of these factors could be lower, such as productivity.

What started as a severe demand shock to the expansion may have larger consequences.

High Unemployment Will Persist

For signs of the nascent recovery, it's worth looking at some real-time gauges of activity, such as restaurant bookings and travel data, rather than traditional economic reports, such as factory orders or even quarterly GDP--because the latter tend to be backward-looking (see "Real-Time Economic Data Shows A Mixed Picture As Lockdowns Ease," June 11, 2020).

While economic activity in people-facing businesses--retail, recreation, leisure, travel, restaurants, and hospitality--has risen from its lows only modestly, Apple and Google mobility data shows some normalization of movement in the U.S., with a strong bias toward driving, walking, and park visits. And while new business applications with planned wages remain 9% below a year earlier, they've recovered to close to normal. Mortgage applications, too, have recovered strongly and are now back to January levels, which bodes well for housing activity in the summer.

This comes as we expect the headline unemployment rate to remain around 7.8% by the first quarter of next year and stay above pre-pandemic levels until late 2023--notwithstanding a May jobs report that many took as a sign of brighter horizons. While nonfarm payrolls added 2.5 million jobs, the gain contrasts with initial jobless claims leading up to the report. Additionally, the jobs gained represented just one-tenth of those lost in March and April, and the drop in headline unemployment to 13.3%, from 14.7%, came with the caveat that severe misclassification of many workers means the true jobless rate was likely 3 percentage points higher than reported.

We continue to anticipate a much larger increase in employment in June as businesses call back employees when the economy continues to reopen or as employers receive PPP loans. The May report didn't materially change our jobs forecast (from mid-April) that unemployment will be 14% in the second quarter, before falling to 8% by year-end. We now expect the unemployment rate to decline to 13.4% in the second quarter. We expect a slower drift down for the unemployment rate later this year, falling to 8.9% in the fourth quarter, almost one percentage point higher than in our April baseline.

Small improvements for Paycheck Protection Program

Based on updated PPP information from the Small Business Association, it seems loans reached more industries in the second round of PPP--relative to the first round--though underlying issues remain (see "The Paycheck Protection Program Update Shows Small Improvements Are In Reach," June 12, 2020). This is important since small businesses account for 47% of total jobs in the U.S.

The average PPP loan was for $114,000, with 4.48 million loans approved through May 30. In the first round, the average loan was $206,000, with 1.66 million loans approved.

But while bit-sized loans improved PPP's reach, the concentration of loans to industries and states less hurt by social distancing remained. At 42.4%, total PPP loans approved to service industries significantly affected by social distancing was only slightly higher than the 41.2% in the first round. The accommodation and food services industry, responsible for almost 30% of total jobs lost during COVID-19, saw its share of loan approvals drop following the first round of PPP. That increases concerns, not only for business survival, but also for their ability to operate at full capacity later this year.

While the May jump is encouraging, we aren't convinced that happy days are here again. Part of May's job strength was tied to rehiring in order to turn PPP loans into grants, as well as because states opened up, and those service sector jobs needed people to mind the stores.

Net job gains look set to pick up in coming weeks as portions of the PPP loans would be forgiven if businesses rehire workers by June 30. We expect another 3.5 million jobs to be added in the U.S. in June. We expect extended hiring to be minimal later on, given depleted balance sheets from lockdown and the great uncertainty as to whether demand returned now that the doors opened.

As for wages, the disproportionate job gains in low-paying industries deflated wage growth. Average hourly earnings fell 1.0% in the month, partially reversing the 4.7% surge in April. The aggregate weekly payrolls index, a proxy for total wages and salaries, which combines employment, average weekly hours worked, and average hourly earnings, increased 3.3%.

Housing Is Already Starting To Pick Up

One sector that seems closer to a near term, possibly even V-shaped, recovery is housing.

The U.S. quarantine did extreme damage to housing indicators in March and April, with housing starts, construction jobs, and existing home sales plummeting in April. However, housing indicators since then have been strong. Mortgage applications for purchase jumped to their highest level since the end of the last expansion (January 2009). This rebound helps temper any concern from a weaker-than-expected May housing report.

And while the May rebound in housing starts was relatively modest, building permits were robust. Building permits, a forward-looking indicator of starts, jumped by 14.4% month over month to 1.22 million annualized, with gains in both single-family and multifamily permits. The widening gap between permits and starts reflects the sizable backlog of projects that will proceed as conditions normalize. Homebuilders' confidence also jumped, by 21 points in June, according to the National Association of Home Builders Housing Market Index--a sign of strong growth in housing starts in coming months.

The housing comeback (as well as a desire to fix "this ole house" that surfaced dramatically during quarantine) helps explain the 17.7% May boost in retail sales, which far exceeded market expectations with the biggest increase on record. Sales are still 8% below their February level. Sales at building materials, garden equipment, and supply dealers surged in May, jumping 9% above February's levels, while furniture and home furnishing sales also rebounded strongly in May.

Taken together, housing starts are expected to improve to 1.23 million this year, after falling to 1.06 million in the second. Housing starts are expected to total 1.21 million in 2020, and climb further to reach 2019 levels of 1.3 million by 2021.

Vehicle unit sales also increased, partly tied to backlog. Vehicle sales were up 40% month over month in May, after plunging by 48% to 8.7 million units in April from 16.8 million in February. There is also a possibility that a number of households (those who can afford it) are shifting their transport preferences away from public transport to travel by car. Automakers also seemed to have adjusted to social distancing rules, making it easier to sell cars without entering showrooms. Excluding autos, retail sales were up 12.4% in May. Core retail sales saw a strong 11% revival--also the largest rise ever--while the annual trend surged back into positive territory to 2.1% year over year from -7.5%.

Chart 3

Chart 4

Time And The Fed Will Heal All Wounds

Amid what turned out to be the worst recession since the Great Depression, U.S. policymakers put their differences aside and agreed on the most monetary and fiscal stimulus in U.S. history.

The federal government's extraordinary monetary and fiscal stimulus helped stabilize credit markets and temper market volatility. Moreover, the lifeline to unemployed workers and businesses strapped for cash likely prevented a much more serious outcome. Previous crises suggest that the long-term damage to an economy comes in part from the crisis itself (e.g., the initial hit to GDP) and in part from shortcomings in the response. Thus, aggressive and early rescue measures can help foster a faster and stronger recovery. The coordinated response by U.S. policymakers, with actions taken abroad, likely helped stabilize what was sure to be an economy way off course.

Given that the latest Fed package represents roughly 10% of U.S. GDP and that policymakers began slashing interest rates as far back as March 3 (with the benchmark federal funds rate now at effectively zero), there's no question the central bank's response has been aggressive and early.

The Fed also seems poised to maintain its historically accommodative monetary policy, with Chair Jerome Powell saying on June 10 that policymakers "are not even 'thinking about thinking' about raising rates."

The Fed's rapid and bold emergency policy response to the crisis restored credit-market functioning, staved off a more severe financial crisis, and provided an estimated stimulus worth 2.1 percentage points to full-year GDP. We expect Powell & Co. to keep the benchmark federal funds rate at (effectively) zero until 2023, with the first hike in second-quarter 2023.

Providing a fair amount of cover for this stance is that a strong disinflationary trend took hold in April, with headline personal consumption expenditures (PCE) inflation cooling to just 0.5% year over year, weighed down by lower energy prices, while core inflation came in at just 1.0%--the lowest since 2010. With slack labor markets amid challenging business conditions, inflation will remain, on average, below the Fed's 2% inflation objective until at least 2023.

We continue to expect the Fed to keep rates on hold until at least 2023. Absent a sustained rise in inflation above its target, the Fed will not tighten its policy rate until the labor market is largely healed. With around 25 million workers dislodged from their jobs in some form or another, according to Fed Chair Powell, the economic outlook is extremely uncertain, which means we wouldn't be surprised if the Fed reached further in its policy toolkit later this year and beyond.

In a June 10 press conference after the Federal Reserve left its benchmark interest rate near zero, Chair Jerome Powell offered a dire outlook, saying the central bank forecasts unemployment to remain high, at 9.3% by the end of the year, and suggesting it could take years for the U.S. labor market to return to anything like it was before the coronavirus pandemic. While we expect a labor-market rebound to come slightly sooner, we think persistently high unemployment will weigh on the demand side of the economic equation for the foreseeable future. And with consumer spending fueling roughly two-thirds of the U.S. economy, this would be a heavy weight indeed.

Is Uncle Sam Getting Cold Feet?

The federal government also didn't pull any punches in authorizing trillions in fiscal stimulus to the U.S. economy. Still, grumblings among policymakers when the question of another vote for more stimulus is raised increase risks that Uncle Sam may have lost interest in providing more stimulus.

As dangerous from a health perspective as the premature loosening of social restrictions can be--potentially giving rise to a second wave of outbreaks--so, too, may be a quick pullback of fiscal stimulus from Washington. The $3 trillion in stimulus passed by Congress clearly prevented a sharper collapse in economic activity early in the year. Today, policy fatigue may pose an important downside risk to the recovery. Recent promising economic indicators also discourage votes for new stimulus, under the assumption that the economy is recovering.

Another federal stimulus package is feasible this year, though it will likely be modest. For example, we could see additional stimulus to help local governments and to top up some of the support programs, especially to save jobs. However, the different perceptions of future needs at the House and Senate, in an election year, suggest that the timing, size, and plan of future stimulus are unclear.

Of equal--if not greater--concern is that the federal government will pull back on the historic fiscal stimulus that, in all likelihood, not only prevented the current recession from being even deeper but also set the stage for a more solid rebound. Even the Fed, whose unprecedented action injected sorely needed liquidity into effectively frozen financial markets, probably won't be able to do much to spur demand if fiscal stimulus wanes.

Upside And Downside Scenarios

Each quarter, S&P Global economists project two scenarios in addition to their base case, one with faster growth than the baseline and one with slower. Scenarios are based on ordinary risks to baseline growth, not extraordinary risks. Even risks surrounding our baseline forecasts are particularly wider this time around.

Table 2

Upside scenario: V for victory!

In the upside scenario, after people adhere to social distancing rules, COVID-19 runs its course, and the U.S. government and Federal Reserve come together to offer support to households and businesses, bridging the gap caused by the shutdown. America blots out remaining COVID-19 hotspots to successfully contain the virus, leaving the U.S. clear of further outbreaks in July. Americans who were stuck at home in the spring come out to enjoy the sun with no fear of relapse heading into the third quarter.

The U.S. economy would experience a V-shaped recovery (compared with a U-shaped recovery in the baseline) in the second half of the year and one more year of solid above-trend growth, as well as significantly higher above-average GDP in 2020 than in our baseline case.

While the world bounces back from the global recession, trade tensions would ease, at least over the near term, between the U.S. and China.

After stumbling in 2018 and 2019 and a COVID-19-related hit in the second quarter, housing would rebound in the second half, with real residential investment climbing 2.8% in 2020, as opposed to 2.5% in the baseline. As U.S. economic activity picks up, the Fed would have room to raise rates gradually, by an additional 25 basis points in 2022, followed by a few more hikes in 2023. The global recovery would help business sentiment rebound across both the industrial and service sectors, with the S&P 500 reaching a 2,378 average in 2021, much higher than 2,308 in our baseline.

Higher-than-potential growth would require businesses to continue looking to hire more folks, keeping the unemployment rate lower in this scenario, falling to 8.7% in 2020 (compared with 9.3% in the baseline) and then to 6.6% in 2021 (lower than 7.2% in the baseline scenario). Continued strength in the labor market would let workers enjoy healthier wage gains throughout next year. Together with the income effect, wealth from a rebound in stock market gains in 2021--helped by a cooling of trade tensions--would lead to higher consumer sentiment.

All of this would be sufficient for a virus-driven slowdown in consumer spending to be less severe, down 4.0% in 2020, compared with the baseline's -4.8%. Strength in the labor market would help push up household formation rates, providing a tailwind to the housing market (compared with the baseline). In this optimistic scenario, after a 3.8% drop in 2020 real GDP growth (much better than the 5.0% drop in the baseline), GDP would jump to 4.7% next year, smaller than the 5.2% gain for the baseline but from a much higher base.

Table 3

Downside forecast: The agony of defeat

Our pessimistic outlook assumes an even steeper contraction in consumer spending than in the baseline forecast and a much longer timeline to bring COVID-19 under control. This would delay the start of the recovery in spending, reduce its vigor, and delay laid-off workers getting back to work.

Consumer spending would plunge by 10.3% (annualized) in the second quarter, compared with a 4.8% drop in the baseline, with further disruption in the fourth quarter on fears that COVID-19 has returned. The contraction in consumer demand and output in the pessimistic forecast is much sharper. From both election tensions and stimulus fatigue, the government is slow to approve additional stimulus, delaying the recovery further. Consumer spending would be down 10.3% in 2020, over twice the drop as in the baseline.

Owing to the sharper contraction and slower recovery in consumer spending and related investment spending by businesses, GDP growth would plunge by 8.7% in 2020 in the pessimistic forecast, with barely a nod to recovery the following year, at just 3.7% growth in 2021.

In this scenario, the peak-to-trough decline is 14.6% (compared with 10.9% in the baseline), but the economy doesn't get back to the previous cycle peak before sometime in the fourth quarter of 2022 (compared with fourth-quarter 2021 in the baseline). By fourth-quarter 2023, GDP would be $811.2 billion smaller than in the December baseline (compared with $313.4 billion in the current baseline).

The larger hit to economic growth in our downside scenario translates into a corresponding higher unemployment rate. The initial degree of dislocation and uncertainty over reemergence of the virus would keep the unemployment rate elevated at close to 9%, on average, before it would finally start to move back down once the all clear is announced in spring 2022. The unemployment rate would average 9.8% in 2020 and 8.9% in 2021 (compared with 9.3% and 7.2% in the baseline).

With the world reeling from the global recession, trade tensions would flare, at least over the near term, between the U.S. and China, giving the private sector more reach to hoard savings rather than invest. Both business and residential investments would be hit hard, with business fixed investment declining both this year and the next. In such a scenario, stock markets would struggle to move up, and just as in our baseline case, central banks would be on an effective zero bound for the next few years, with no rate hikes expected through 2023.

Table 4

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Writer: Joe Maguire