Although a blanket of snow covered much of the U.S. this winter, the country's economy has warmed. Signs show that a strong recovery, albeit delayed, is starting to take hold as strengthening sentiment readings indicate that people are ready to let the good times roll.

An improving vaccination outlook, faster reopening schedule, and the $1.9 trillion stimulus "shot in the arm," along with a $900 billion package approved in December, all point to a seismic shift in the U.S. economic outlook relative to where it stood in December 2020. Our forecasts of real GDP growth for 2021 and 2022 are 6.5% and 3.1%, respectively, up from 4.2% and 3.0% in our December report, with our 2021 GDP forecast (and now the Fed's) targeting the highest reading since 1984.

With both business and consumer confidence well into expansion territory, the U.S. economy is on the mend. Even accounting for a possible resurgence of the virus later in the spring, it's hard to see a contraction this year that is severe, broad, or long-lasting enough to be considered a recession by the National Bureau of Economic Research. Our risk for recession over the next 12 months is now 10% to 15%, down sharply from the 20% to 25% range in January and around the U.S. economy's long-term unconditional recession risk average of 13%.

Table 1

The American Rescue Plan (ARP), which was signed into law on March 12, will lend a generous helping hand to the U.S. recovery this year and the next, boosting economic activity by an additional $503 billion in 2021 alone, and helping create 600,000 more jobs in 2021 than without the ARP. However, demand-driven stimulus is temporary and usually doesn't pay for itself. Other fiscal policies, such as infrastructure, if chosen wisely, may be a long-term solution, providing the productivity boost needed to help get the U.S. expansion back on track. President Joe Biden is expected to prioritize infrastructure with a bill in the fourth quarter, helped by another reconciliation available this calendar year.

While the economy may have turned a corner, the road ahead is long for the millions who remain unemployed. The recovery in U.S. jobs growth remains soft, despite recent job gains, and the labor market is 9.5 million jobs short of the pre-pandemic peak. And while the February unemployment rate was down to 6.2%, 10 million people are still unemployed, with 41.5% long-term unemployed. The unemployment rate is even higher (8.6%, or 14.2 million people) when adjusting for a smaller labor force since February 2020.

At its March meeting, The Federal Open Market Committee (FOMC) seemed to agree. While the Fed sharply revised up its GDP forecast, it was clear that it expects inflation to remain low, despite a likely spike in inflation in the second quarter on COVID-19 distortions. Moreover, it emphasized that with around 10 million people without jobs, the jobs market is far from healed. With that in mind, we see the Fed staying on the sidelines until it begins to slow down its large scale asset purchases in second-quarter 2022. We expect its policy interest rate won't "lift off" until third-quarter 2023.

Stimulus: Taking Care Of Business

President Biden kept his word, stabilizing the health of the American population and the U.S. economy.

The pace of COVID-19 vaccines administered picked up, crossing 2.3 million vaccinations per day (seven-day average) in the week of March 16 as weather and supply improved. The Biden Administration now says that all Americans will be eligible for vaccinations by May 1, with the nation closer to normalization by July 4. Meanwhile, daily new cases and hospitalization rates continue to decline, and authorities are easing restrictions on social distancing, all pointing to a solid second half of the year.

Chart 1

In addition to "shots in arms," President Biden called for "money in pockets" in the form of the ARP, which will lend a generous helping hand to the U.S. recovery this year and the next. We now expect the U.S. economy will return to 2019 levels in the second quarter, one quarter earlier than without the stimulus. We estimate the ARP boost to GDP will be $499 billion (annualized) through 2023 (see chart 2). We see the unemployment rate falling to 5.1% by fourth-quarter 2021, one percentage point lower than without the ARP, and hitting precrisis levels by mid-2023, three quarters sooner than otherwise. This is largely in line with our earlier assessment of a $1.9 trillion package (For more on this, please see "Economic Research: Within Reach: How Stimulus Proposals Lift U.S. GDP To Pre-Pandemic Levels," Feb. 1, 2021.)

Chart 2

Although the demand-driven stimulus programs accelerate "filling in the demand hole" while in place, they are temporary, and are expected to have little impact on still-low long-run productivity. Once the stimulus ends, we see real U.S. GDP growth slowing to 1.9% on average in 2023 and 2024, just about its potential growth rate. Unfortunately, the Congressional Budget Office sees potential growth slowing further, to 1.7% by 2030.

Government investment in infrastructure is one way to reverse course. We have found a $2.1 trillion infrastructure program, similar in size to the $2 trillion proposed by President Biden as a candidate, if done wisely, would add an additional $5.7 trillion to the economy over a 10-year period, adding 2.4 million jobs to the economy by 2024. While many of these project-related jobs would end, the productivity boost from infrastructure would create 713,000 more jobs by 2029 than without an infrastructure plan (see "Economic Research: Infrastructure: What Once Was Lost Can Now Be Found--The Productivity Boost," May 6, 2020).

Jobs: A Hard Day's Night

While economic conditions have improved dramatically for many from a year ago, with the unemployment rate less than half its April peak of 14.75% (the highest rate in its 73-year history), the U.S. still faces a bumpy road to recovery, with many people left on the side of the road.

U.S. jobs growth jumped by 379,000 in February, following a two-month pause and almost twice consensus estimates, though near our forecast of 350,000. But underneath the positive headlines are scars. The labor market remains 9.5 million jobs short of the pre-pandemic peak, and we estimate it is 11.7 million jobs below its pre-pandemic 12-month trend. The unemployment rate, down by 0.1 percentage point to 6.2%, still leaves almost 10 million unemployed in February.

Chart 3

We expect further improvement in the labor market later this year as vaccinations, combined with likely additional fiscal support to private-sector and state incomes, pave the way for a strong rebound.

However, many workers have fallen between the cracks. While the number of jobs grew in February, the average number of hours worked dropped, to 34.6 per week from 34.9, and total hours across all private payrolls fell 0.5%. Since hours are a proxy for output, economic activity might have shrunk in February. This also indicates that most of the jobs gained in February were less than full-time (although the number of part-time workers didn't change much). For example, the average workweek in leisure and hospitality fell to 25.3 hours from 25.8 hours, even as the number of jobs increased in the sector. The number of unemployed designated as "permanent job losers" held at 3.5 million, with the share to total unemployed remaining elevated around 35.1%, a level last seen in 2012. Moreover, the share of long-term unemployed, at 41.5%, has also not seen since 2012. This will likely be a lingering problem, since the longer a worker stays unemployed, the harder it is to rejoin the workforce. Rightly or wrongly, business managers assume that their skills have atrophied and don't offer them a job. The worker loses income, and the economy loses their productivity.

Consumer Spending: Nesting Instinct

While the labor market is a weak point, spending has been the answer, helped by stimulus checks, unemployment benefits, and a pension to fix up our homes.

The stimulus checks from the December COVID-19 relief package helped lift January personal income by 10% over December as government transfers surged by 52% in January. Most of those checks went into the bank, with the personal saving rate rising to 20.5% from 13.4% in December. The increased transfer amount (more than double) to support households from the March relief package suggests the saving rate will climb even higher in March, leading to higher accumulated excess savings in the beginning of the second quarter.

The personal saving rate is now almost three times its precrisis historical average back to 1980 of 7.3%, and, extending the data to 1959, higher than its 1975 peak of 17.3%. Now holding well above its historical average for nine months, the average household will likely have the accumulated savings to boost spending once the crisis is over. Indeed, if we compare it to 2019 personal savings (monthly average), we see significant excess savings to the tune of $2.7 trillion. These excess savings in the pocket will boost consumption further once COVID-19-related restrictions wane.

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The handicapping of discretionary spending, particularly for high-income households--whose vacations and leisure activities, for example, had been canceled for the foreseeable future--left households with more cash on hand. And while people will pick up discretionary spending on news that the virus looks likely to be contained in the near future, many canceled vacations are permanently lost, leaving savings healthy over the near future.

Increased savings also went to pay down debt. After the largest string of debt increases since 2001, consumer credit fell by an annualized 0.4% in January. With discretionary spending curtailed, credit card debt fell by any even larger 12.2% for the month, the seventh straight month of decline. In contrast, nonrevolving debt, such as student and car loans, increased by an annualized 3.2% for the month. Overall, while some of that extra cash from canceled leisure activities went into home furnishings or to pay down debt, it wasn't enough to offset the extra savings. After falling by 3.9% last year, a 73-year record low, we expect consumer spending to jump by 6.9% in 2021, a 66-year high, and 4.2% the following year. The saving rate will remain in double-digit territory this year, at 14.2%, before falling back to 7.3% in 2022, the same as its fourth-quarter 2019 rate.

Despite paying down debt and putting cash in the bank, people were still able to spend. Consumer spending rose by 1.8% in January. Spending remained concentrated on durable goods, particularly home-related items as people either want to furnish the new home they bought, or fix up the one in which they are cloistered. As expected, spending in services was 7% below February 2020 levels, with the drop largely in transportation, food services, and entertainment. On the other hand, durable goods spending was 11.2% above precrisis levels, after surpassing its February level last July.

The brutal snowstorms in Texas and the southwest, together with the post-holiday lull, resulted in a hefty 3.0% month-over-month retail sales drop in February, down 2.7% excluding autos. Only gas station sales were up, 3.6% for the month, supported by a 6.4% increase in gas prices. Despite a large percentage drop, monthly sales levels for January and February were the highest in history, more than offsetting the three-month drop through December, from both people quarantining and a decline in holiday spending.

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Chart 6

An improving economic outlook driven by COVID-19 containment, together with another installment of stimulus from Uncle Sam, amid sizable savings tucked away point to strength in consumer spending. We see consumer spending rebounding this year and the next, to 6.9% and 4.2%, respectively, as people step out of their homes and spend.

Discretionary spending on customer-facing services, once in hibernation, will wake up this spring, with solid spending activity this year and the next. While car sales and other purchases of durable goods will benefit from this support, saturated demand after loading up on durable goods during the crisis will limit the upside. Car sales will increase to 16.6 million cars in 2021, before dipping slightly.

Housing: What Goes Up

The housing market continues to shine, helped by fatter savings accounts (for some), low mortgage rates, and a desire to move away from urban areas coupled with remote work allowing people to pick up and move to the suburbs. We expect home sales to slow starting in the second quarter as winter storms, a spike in mortgage rates, and higher building costs dent housing demand. While we expect housing to moderate, with housing starts drifting down to 1.46 million by the fourth quarter, this comes after 14-year highs for pending, new, and existing homes sales last year.

Chart 7

Prices climbed during the recent housing boom, with prices up to an eight-year high in January (year-over-year basis), according to the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index. However, with improvement in supply and demand for homes likely to slow later this year, we think some of the air may seep out of the market. We expect the pace of price gains to slow, stabilizing sometime in the first quarter of 2022.

Inflation: Quiet. Too Quiet.

Outside of home prices, inflation readings remained soft through February. The U.S. Consumer Price Index (CPI) accelerated to a 1.7% year-over-year rate versus the prior month's 1.4%, while the measure excluding food and energy slipped to 1.3% year over year compared to 1.4%.

Virtually everyone is expecting prices to jump starting next month as the base effects from last year's extremely low pandemic-driven consumer prices kick in. The reopening spending party is also expected to begin, fueled by the ARP, kicking inflation into overdrive for the next few months.

Markets believe that the pandemic is over, and with that expect to see many businesses reopening and more job gains on the horizon. Moreover, they envision that extra support from the ARP will ignite the U.S. recovery, sparking aggregate demand and leading to higher prices in the not-too-distant future. A stronger economic outlook with increased stimulus has sounded alarms for inflation hawks.

While the Fed and S&P Global Economics see these inflationary pressures as transitory, markets are pricing in ongoing reflationary pressure that they believe will force the Fed's hand to lift rates sooner than projected by the FOMC's latest summary of economic projections (the so-called "dot plot"). Markets are now pricing in CPI, five years out, reaching over 2.4%. That is three times 0.8%, where market inflation expectations were as of May 2020, the likely end of the COVID-19 recession. We suspect the Fed will not be swayed by a temporary spike in inflation, as it has repeatedly said it won't budge until inflation has been sustainably above 2% "for some time."

Chart 8

Still, we will no doubt see extreme year-over-year price gains over the next two or three months coming off last year's extreme lows, as well as from supply constraints given low inventories while reopening. We believe these moves will be transitory, giving the Fed more time to remain very accommodative. We expect headline and core year-over-year gains to rise sharply into late first quarter and second quarter, with rising energy prices affecting the headline and harder comparisons lifting both measures. With headline and core CPI at 1.7% and 1.3%, respectively, in February, we assume respective peaks of 3.3% and 2.3% in the second quarter.

We agree with the Fed. We believe that these near-term price moves will be transitory, giving the Fed more time to remain very accommodative. We expect that once these temporary forces dissipate later this year, prices will divert back to their previously low rates, which will keep the Fed in check for now.

We expect CPI will decelerate to around 2.1% in 2022 after surging to 2.7% the year before. Core CPI will drift higher, to 2.1% in 2021 and 2.2% in 2022, from 1.7% in 2020. The Fed's preferred price indices, personal consumption expenditures (PCE) and core PCE, were both at 1.5% year over year in January. Our forecast implies that core PCE inflation will average 2.1% and 1.9% in 2021 and 2022, respectively, after coming in at 1.4% in 2020. That's a far cry from where the Fed would like to see rates before "lift off," which we believe gives the Fed a lot more time than markets think.

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Federal Reserve: There Must Be Some Misunderstanding

The Federal Reserve is once again at a crossroads with markets pricing in a rise in interest rates much sooner than the Fed is broadcasting, both in public comments and in the dot plot. During Fed Chairman Jerome Powell's press conference and in his Wall Street Journal opinion piece last Friday, he emphasized that while the U.S. economic outlook is "brightening," the recovery is "far from complete."

The Fed's median projections anticipate the fastest yearly GDP growth in 37 years, at 6.5% for 2021--in line with our forecast--with a forecast of 3.1% the following year. Median projections also anticipate a lower path for the unemployment rate and slightly more inflation than earlier thought. But, in contrast to market expectations, the Fed is clear to point out that it expects the pickup in inflation to be transitory. Moreover, as Chair Powell highlighted during his March FOMC press conference, as the "economic downturn has not fallen equally on all Americans," they are looking at a dashboard of indicators, not just the headline unemployment rate.

In contrast to markets, which are pricing in a 25 basis point rate hike in 2022 and possibly another in 2023,the majority of FOMC participants anticipate the first rate hike will be in 2024, with a minority of FOMC participants expecting a move in 2023 (four out of 17), and only one participant anticipating a move next year. We currently fall in the 2023 camp, though we recognize that this depends on the data and know that whatever we think, the Fed has the final word.

On the plus side, all the factors shaping the market's expectations for a near-term Fed hike are exactly what the Fed has hoped for: a stronger economy will support the Fed's efforts to reinflate the economy after year-over-year core PCE inflation has remained stagnant at around 1.8% over the last 10 years and at just 1.7% over the last 12 months, precrisis. We now expect the Fed's interest rate "lift-off" to start in third-quarter 2023, almost one year earlier than our December forecast, with balance sheet reduction (as a share of GDP) beginning in 2023.

On the downside, the Fed has indicated that it is worried about disorderly bond markets, with Chair Powell noting on March 4, that "it caught my attention." Bond yields have shot higher in recent weeks on mounting expectations of stronger economic growth and faster inflation. Trading has been turbulent at times as dealers have struggled to keep up with the order flow. That said, the FOMC seems unlikely to adjust its quantitative easing purchases to try to cap rates.

Market distortions aside, we revised up our 10-year Treasury yield forecasts by 30 basis points for this year and the next, given the recent firming in Treasury yields on the back of a healthier economic outlook. If markets are correct, a firmer interest rate environment will weigh on some rate-sensitive components of aggregate demand, such as housing and durable goods. We anticipate auto sales will stabilize a little under 17 million units per year while housing starts will revert back to a more sustainable demand pace of 1.45 million units per year.

Sharply higher Treasury yields took the U.S. dollar higher last week, despite the dovish FOMC announcement on March 17. Likely in response to the Fed's benign neglect of rising price pressures, the 10-year yield closed at 1.7% on March 22, well above its year-end 2020 reading of 0.92%.

We continue to expect the dollar to appreciate over the near term, then depreciate modestly over the coming years, to support net exports. Firming interest rates help stabilize the dollar, suggesting some upside to our forecast.

Table 2

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. In this report, scenarios are based on risks to baseline growth coming from the timing of vaccine availability to the wider public, strength and duration of capacity restrictions, and amount of further fiscal support.

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Upside: Walking on sunshine

In our upside scenario, the $1.9 trillion stimulus-driven recovery, together with a massive vaccine push, allows the U.S. to reach herd immunity a little sooner than we previously thought. Households, itching to go out and celebrate with friends and family, dip into their savings accounts to splurge on the leisure activities that they have neglected for most of the year. Consumer spending surges to a 78-year record high of 7.7% in 2021 and 5.0% the following year, above 6.9% and 4.2% in the baseline.

Optimism over future economic conditions encourage businesses to open up their bank accounts. Equipment spending surges by 13.6% and 4.0% this year and the next, while nonresidential construction increases by 0.8% and 7.2%, respectively, with relative gains over the baseline increasing in 2022 as confidence improves. In the upside scenario, the U.S. economy rebounds 7.0% in 2021. It continues to outpace our baseline in 2022, growing 3.6%.

Higher growth rates also mean the unemployment rate falls under 4% by mid-2022 and core CPI inflation (actual and expectations) starts to average 2% consistently on a 12-month-rolling average basis in the second half of 2022. The Fed raises its policy rate for the first time in this recovery in early 2023 (versus late 2023 in baseline).

Table 3

Downside: Hello darkness, my old friend

In our pessimistic scenario, the economy still grows at an impressive 5.4% annual average pace in 2021, faster than our pre-stimulus baseline growth of 4.2% published in December. While in other times this may be impressive, in today's context of an almost $2.8 trillion fiscal stimulus to work with on top of households' excess accumulated savings, it is a disappointing outcome.

In this scenario, the negative news cycle regarding virus variants keeps consumers cautious. Businesses start opening and nonresidential investment picks up, but not as much as in our baseline. The S&P500 barely moves up, while improvement in employment levels is slower compared to our baseline. The impact of government stimulus and spillover effects display multiplier impacts near the lower end of historical experience. Pent-up demand is unleashed, but only half-heartedly.

In such a scenario, the unemployment rate doesn't get back under 4% until 2024. Inflation averages below 2% once the base effect runs out in the first half of 2021. In such an economic environment, the Fed is in no rush to lift rates any time before the second half of 2024, when the unemployment rate finally reaches pre-pandemic levels.

Table 4