NEW YORK (S&P Global Ratings) July 22, 2020--With the number of COVID-19 cases climbing nationally at a dramatic rate, uncertainty for the U.S. economy is elevated again. High-frequency real-time economic data, which first hinted at a start of normalization in May, now suggests that the recovery may be losing steam. (For more, see "U.S. Real-Time Economic Data Suggests Hopeful Signs Of A U.S. Recovery Could Be Short-Lived," published July 16, 2020.)

While it may be premature to sound the alarm for an even worse outcome, the recovery is facing increased challenges with the spread of COVID-19. This is all while government stimulus measures are set to expire.

S&P Global Economics now thinks the probability of an even worse economic outcome is 30%-35%, up from 25%-30%. Although our base case is for a gradual recovery through next year, the surge in COVID-19 and hospitalizations has raised concerns that a more likely scenario is that the COVID-19 recession has not bottomed out.

Assessing The Impact Of State Reclosures

The reclosures in a number of states will most certainly change the U.S. economic outlook. It depends on how many states close and how long these state closures remain in place, with the path of the virus dictating the terms. Already states such as California, Texas, and Florida--which are ranked in the top five states by GDP measure and together account for close to 28% of the economy--have started instating and reinstating restrictions on indoor and group activities.

An unpublished document prepared for the White House Task Force and obtained by the Center for Public Integrity recommended that 18 states in the coronavirus "red zone," which includes the above mentioned states, should roll back reopening measures amid surging cases. If these 18 states complied with recommendations, around 47% of the U.S. economy would be affected by restrictions on indoor and group activities--leading to another round of business closures soon after they opened their doors.

Moreover, with about 40 states seeing rising infection rates--as the U.S. hit an all-time high in July--the worry is that even more state economies will be forced to reinstate social distancing measures yet again. On top of that, U.S. households may choose to self-quarantine, leery that the virus is still lurking.

With that said, the bounce back in third-quarter real GDP growth--of 22.2% (annualized)--in our June forecast is now at risk of weakening. How dramatic a turn depends on how many states are forced to close, and how long before COVID-19 is finally contained. We already saw what one and a half months of lockdown can do to the economy. With a whopping 33.6% (annualized) drop expected in the second quarter, we estimate that the U.S. economy lost a cumulative 11% in growth in the first half of the year, almost three times the Great Recession in one-third the time.

Using lessons from recent history, and recognizing that the path of COVID-19 is highly uncertain, we consider how reinstating social distancing measures may be this time around to gauge the cost to the economy.

It has been about two months since U.S. states began the process of reopening. Indeed, many states, businesses, and households are still following some form of social distancing--as seen in still low indoor-dining reservations, hotel stays, and air travel activity. So, with only a modest lift-off from the April bottom, perhaps there may not be that far to fall. (That assumes Uncle Sam doesn't turn off the stimulus prematurely, which remains an open question.)

But, a second round of quarantine comes after businesses were forced to close only a few months ago.

COVID-19 already dealt a major blow to a number of businesses, with U.S. courts recording around 3,600 businesses have filed for Chapter 11 protection in 2020 through June, up 26% over last year, according to the Wall Street Journal.

We suspect that of those businesses that survived, many likely were forced to downsize. S&P Global Ratings retail analysts found that retail chains have already announced plans to close approximately 6,000 stores in the U.S. permanently, year to date through July 21, based on Business Insider data. According to a June 25 "Yelp: Local Economic Impact Report" on the impact of COVID-19 on businesses, of all closures on Yelp since March 1, 20% are for retail businesses and 17% are restaurants. 35% of those retail businesses closures were permanent, while 53% of those restaurant closures are indicated as permanent.

Big questions looming are how many of the businesses that survived the first round of closures will be able to make it through a second wave, and of those that survive, will they be able to rehire? Workers who were unemployed for "temporary" reasons are at a greater risk now of losing their positions permanently (for which workers have no expectation of returning to their previous employers), which means longer spells of unemployment.

Further Stimulus Is Key To Avoiding Another Dip

How successfully the U.S. economy withstands another assault from the virus will, in large part, depend on decisions by Uncle Sam.

The U.S. economy faces a fiscal cliff at the end of the month as many CARES Act stimulus programs, including extended unemployment benefits for millions of workers, are set to expire. We believe that if they are allowed to lapse, the impact would likely be severe with lasting scars. Indeed, according to testimony on July 17 by former Federal Reserve chairs Janet Yellen and Ben Bernanke, the U.S. could face deep, permanent economic damage without more than $1 trillion in further stimulus.

By way of example, the Federal Pandemic Unemployment Compensation (FPUC) program, which gave eligible unemployed workers an extra $600 in federal benefits each week, will expire at the end of this week if Congress doesn't reach an agreement. One recent proposal was to cut the weekly benefits to $400. Assuming about 20 million beneficiaries, that would mean a $36 billion income cliff for August and September. Holding all else constant, and assuming the lost money would be spent, means third-quarter growth would be 18% (annualized) instead of 22% (our June forecast). While not factored into our analysis, this lost spending would mean further job losses, making the overall impact on the economy even worse. And with federal moratoriums on government-backed loans and on tenant evictions from FHA-secured properties also set to expire, the impact would only snowball.

The Paycheck Protection Program is also set to expire, leaving many small businesses struggling to survive a second round of business closures. This is happening while state and local government budgets are severely depleted, leaving their own policy hands tied in the midst of the new COVID-19 assault. Federal government actions to both contain the virus and extend stimulus programs until private demand has sufficiently recovered are key in avoiding another downturn. But the clock is ticking.