As the U.S. heads into the summer heat, the economy is sizzling. A better vaccination outlook, a faster reopening schedule, and $2.8 trillion from two stimulus packages have turbo-charged the U.S. economic recovery this year and the next, with supply constraints (businesses unable to make products fast enough to meet surging demand) preventing the economy from swelling at an even larger pace than we currently expect. Our forecasts of real GDP growth for 2021 and 2022 are now 6.7% and 3.7%, respectively, up from 6.5% and 3.1% in our December report, with our 2021 GDP forecast (and now the Fed's) targeting the highest reading since 1984.

Chart 1

With both business and consumer confidence well into expansion territory despite inflation concerns, the U.S. economy is on the mend. Households are swapping their nesting instinct for their social butterfly wings, helped by a strengthening jobs market and around $2.4 trillion in excess savings in household bank accounts. And businesses, with their biggest complaint that they can't build products fast enough to meet growing demand, have begun to add capacity. Rebuilding capacity shortfalls in the first half of the year leaves the U.S. recovery on firm footing heading into the second half of the year.

Even accounting for a possible resurgence of the virus later in the year, 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%.

Despite the improved outlook, it appears the job market still has a long way to go before it recovers the jobs lost from COVID-19. The recovery in U.S. jobs growth remains soft, despite recent job gains, and the labor market is 7.6 million jobs short of the prepandemic peak. And while the May unemployment rate was down to 5.8%, 9.3 million people are still unemployed (not counting under-employed), with 41% long-term unemployed (defined as unemployed for 27 weeks and over). The unemployment rate is even higher, at 8.1%, when adjusting for a smaller labor force since February 2020. On a positive note, the extremely tight jobs market may offset the usual roadblocks that apply to the long-term unemployed, making it easier for them to find work once pandemic-driven constraints are lifted.

Supply and labor bottlenecks are now driving price gains, as business activity catches up to the demand surge stemming from reopening, which has kept a lid on the pace of job gains. Given capacity constraints, we expect the economy to fully regain the 22.4 million jobs lost from the pandemic by fourth-quarter 2022 and the unemployment rate to reach its 2019 range of under 4% by first-quarter 2023.

Table 1

At its June meeting, The Federal Open Market Committee (FOMC) highlighted a more optimistic outlook than in March. Based on the latest summary of economic projections (the so-call "dot plot"), FOMC members sharply revised up their median GDP and PCE inflation forecasts (4Q/4Q) to 7.0% and 3.4% for this year and 3.3% and 2.1% for the next. Based on that more rosy assessment of the U.S. economic outlook, they also moved up the expected timetable for higher interest rates. FOMC members continued to emphasize that the price run-up was "largely transitory", though with less conviction than in the past, as Chairman Jerome Powell noted at his press conference the need for a dose of "humility" in forecasting.

The dot plot now indicates that the Federal Reserve's first rate hike in this cycle will be in 2023 (previously 2024), with another to follow in the same year, though policymakers indicated that the economy hasn't yet seen "substantial progress,"--what the Fed needs to see before it tapers bond purchases. With that in mind, we now see the Fed staying on the sidelines until it announces that it will begin to taper its large-scale asset purchases in fourth-quarter 2021 (was first-quarter 2022). We expect policy interest rate "lift-off" to be one hike in first-quarter 2023, with the second rate hike in the third quarter, and two more hikes in 2024.

Now that the American Rescue Plan (ARP) is pumping through the U.S. economy, attention has turned to another package--infrastructure. It is increasingly likely that some form of infrastructure will be made into law this year, helped by another reconciliation available to the president this calendar year. Indeed, on June 24, President Joe Biden and a group of centrist senators agreed to a roughly $1 trillion infrastructure plan on U.S. transportation, water and broadband, though it still needs to get approval on Capitol Hill. Unlike the ARP, which is demand-driven stimulus that usually doesn't pay for itself, 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. While not in our June forecast, an infrastructure package around the size of $1 trillion, and assuming the Congressional Budget Office (CBO) average multiplier of 1.3x, would likely add a cumulative $1.3 trillion to GDP by 2027. If closer to the CBO's high multiplier estimate, it would add $1.8 trillion.

Jobs: Moving (Slowly) On Up

The job market's road to recovery continues to be a long one. Fortunately, for relatively benign reasons, demand has outpaced business capacity to hire new workers. The solid number of 559,000 new jobs added to the rosters in May, though impressive relative to the prepandemic full employment economy, still wasn't nearly enough to meet current business needs. With nonfarm payrolls still down by 7.6 million (5%) from February 2020, there is still quite a bit of road to travel. If the economy continues at this current pace of job gains (540,000 average over the last three months), the U.S. jobs market wouldn't regain the 22.4 million jobs lost until mid-2022. But that average monthly pace would be difficult to maintain past the third quarter as these jobs that are becoming available during the economy's reopening are the low-hanging fruit. We expect to reach the prepandemic milestone only in fourth-quarter 2022 and to remain short of the prepandemic maximum employment trajectory in our forecast horizon.

Chart 2

The unemployment rate was a bright spot in May, falling to 5.8% (9.3 million), as we expected, after edging up to 6.1% in April and compared to 13.3% a year ago. However, adjusting for labor force composition, the unemployment rate fell to 8.1% (was 8.4%), indicating that there is still room to improve. While the drop in labor force participation to 61.6% from 61.7% was a disappointment, the overall reading isn't as worrisome as the headline numbers indicate and workers have reason to be hopeful. The full mix of data shows only a modest shortfall in hours worked, with current employees working much longer hours at apparently elevated pay. Average weekly hours, a leading indicator for business employment needs, was steady at a high 34.9 hours, and average hourly earnings rose 0.5% month-over-month in May after surging by 0.7% in April (the 12-month pace jumped to 2.0% over last April as pandemic-driven effects were unwound). As businesses reopen and the economy strengthens further this year, we expect people who sat on the sidelines to rejoin the workforce, optimistic that they'll land a job this time.

The tight jobs market has left frustrated businesses pointing to the federal supplement for recipients of unemployment benefits as why they can't fill positions. While that may be a reason for some workers, a variety of other factors could also be contributing to constrained job growth. Those issues include some workers' concerns about contracting the coronavirus, child-care responsibilities preventing some parents from returning to work, or a skills or location mismatch (as people moved away from crowded urban areas during the pandemic). We will be closely watching job numbers in September, a possible triple-witching month when schools across the nation reopen, the U.S. potentially moves closer to herd immunity rates, and extended unemployment benefits expire. We continue to expect that near-term labor market shortages will likely be a constraint this year on U.S. GDP as businesses return to normal. The path will not likely be a smooth one, despite a faster vaccination rollout and reopening schedule leading to an increase in mobility. Still, while reopening the economy is not like turning on a light bulb, we believe we're starting to see a light at the end of the tunnel.

Household Spending: Hot Fun In The Summertime

For consumers, the party is only just getting started. Household spending, bolstered by accumulated savings from the generous government support, continued to rise as the economy reopened and the labor market steadily recovered. Low-income households continue to spend more relative to the prepandemic normal than high-income households. The recovering jobs market has helped land people jobs. And for those still unemployed, unemployment benefit boosters from the federal government (which expire in June and July for half of the states and in September for the rest) have helped. In normal times, benefits replace only a fraction of lost earnings, but the CARES Act replaced more than 100% for two-thirds of unemployed workers, boosting low-income household spending.

We expect the U.S. economy to experience a summer boom, fueled by reduced virus fears, elevated savings, and a pick-up in wages. Already witnessed in the spending data, the consumer basket is rotating from goods to services as people shed their quarantine blues. While total retail sales disappointed in May, spending on restaurants and bars rose 1.8% month-over-month from the prior 4.5% gain, as did purchases on clothing (up 3.0%). Our June 11 real-time economic tracker report indicated that spending on customer-facing services continued through mid-June. Both the number of seated diners and the traffic congestion trends in parts of the country reached or surpassed their prepandemic levels in late May, despite a small decline in the first week of June. While air traffic was 25% below its 2019 average, it was up from 33% below 2019 levels last month. As the U.S. approaches herd immunity and the holiday season nears, we suspect airline traffic will pick up further as people visit family and friends that have been sorely missed during quarantine. (See "U.S. Real-Time Data: Job And Mobility Trends Improve As Rising Prices Dampen Consumer Enthusiasm," June 11, 2021.)

Chart 3

Pre-opening, the early household spending spree revolved around quarantine. Accepting the fact that the world was homeward-bound, people decided to fix up what they've got, or buy a new house, away from crowds, as well as new furnishings to make it feel like home. But with the virus apparently contained in the U.S., for the most part, and with the upward march of home prices, the pace of home purchases, and with it home furnishings, has slowed. Existing home sales fell to 5.75 million in May, versus a 14-year high of 6.86 million in October. Given existing home sales are tracked at closings, the poor weather in February--which likely kept people from shopping for homes--explains some of the weakness. But the recovery in most housing measures has ticked lower in the second quarter. After reaching a 15-year high of 993,000 in January, new home sales have mostly fallen recently, closing at 880,000 units in May.

In the face of massive home demand, new construction lagged sales through most of the expansion, leaving housing market inventory extremely low. The months' supply of existing homes posted a string of all-time lows over the last five months to just 1.9 months through January. It has picked up to a still-low 2.4 months in April. The months' supply of new homes rose to 4.4 from 4.0 in March (was 3.6), just over the all-time lows of 3.5 in August. We expect to see a steady ascent in starts and completions this year, in the face of extraordinary home demand. Capacity constraints pushing construction costs and home prices higher will cap activity, with growth in sales moderating this year and the next from the highs we saw in late-2020. In the first two years of our forecast, housing starts are expected to rise to a 15-year high of 1.59 million units in 2021, peaking in the third quarter of 2021, and slipping to 1.53 million units in 2022.

Chart 4

Nonresidential Construction: Don't Bring Me Down

As the economic recovery surges this year and the next, real nonresidential (business) fixed investment is expected to benefit across most sectors. We expect nonresidential fixed investment to increase by 7.9% this year and 4% on average for the next two years before slowing to a still-healthy pace of 3.3% in 2024. As the economy broadly recovers, businesses will try to add capacity to keep up with quickly recovering sales. While costs are rising, given severe postpandemic supply shortages, still-low interest rates, helped by the Fed's commitment to stay accommodative for some time, will help support investment spending. The increase in overall investment spending this year is largely driven by robust increases in equipment spending (15%) and intellectual property products (7.5%).

Chart 5

Nonresidential construction remains the laggard, with a 6.2% decline in structures spending in 2021. Nonresidential construction is normally a lagging sector, and could be even more so in this recession because of the sluggishness of the recovery. The problem is the high vacancy rates in office and retail developments have yet to show signs of easing. While other business investments are already above their prepandemic levels, nonresidential construction is more than 17% below levels seen before the pandemic shut down operations starting in March 2020. Currently, we expect investment in non-residential structures to have bottomed out in first-quarter 2021 and a recovery beginning in second-quarter 2021 to get back to prepandemic levels not before 2024. Thereafter, all three major categories of business fixed investment will be in positive territory through 2024.

Infrastructure: Build Me Up

As the back-to-back stimulus checks work their way through the economic system, the federal government is in negotiations to pass an infrastructure bill. With the two sides of government close on the size of the package but far apart on how to pay for the plan, the question is now whether Biden will work with both sides of the aisle to form an infrastructure plan that both political parties will embrace, or rely solely on Democrats and the reconciliation process, which requires a slim majority to pass bills.

A joint statement from a coalition formed by the U.S. Chamber of Commerce, nonprofit group Business Roundtable, and political organization No Labels called on Biden to embrace the bipartisan proposal from the moderate House Problem Solvers Caucus on traditional infrastructures such as highways, roads, and bridges and another bipartisan proposal of similar size. As Biden emphasized, and the statement notes, there is no such thing as "Republican bridges, Democratic airports, Republican hospitals, or a Democratic power grid," this reasoning may appeal to him. A bipartisan agreement would also leave the reconciliation option available to Biden if another sticky issue appears later this year.

Our infrastructure report in May 2020 found that a $2.1 trillion infrastructure program, similar in size to the $2 trillion program proposed by 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 by 2024 and the productivity boost would create more jobs later on.

Fortunately, the U.S. economy looks a lot better than in May 2020. But with an improving economy there are higher costs of production, making our 2020 multiplier less feasible today. Still, interest rates remain rather low. And while the jobs market has improved dramatically, the unemployment rate, currently at 5.8%, or 8.1% when adjusted for all the people who left the workforce since February 2020, suggests that there are still people looking for work. Recognizing that commodity prices are very high today, if indeed, they are "transitory" as the Fed believes, prices would be lower when the shovel hits the ground. With that said, we believe the multiplier today would still be above its 1.0x neutral mark. Or in dollar terms, the project will create more in economic activity than it would cost. But even if we used the CBO's average multiplier from infrastructure investment, the U.S. economy would still add an additional $1.3 trillion to the economy over the project's time frame, with more benefits later on, assuming the project was productivity generating. While our June forecast does not consider an infrastructure package in our analysis, we suspect that economic benefits would outweigh costs, with a multiplier closer to the CBO's high multiplier of 1.8x.

The type of project matters when measuring its economic gains. Transportation infrastructure for highways has been measured to have a multiplier of around 2.0x, according a 2012 San Francisco Fed study. And according to a March 2021 IMF study, estimated multipliers associated with green spending are about 2x-7x larger than those associated with non-eco-friendly expenditure, depending on sectors, technologies, and horizons, suggesting "that 'building back better' could be a win-win for economies and the planet."

Inflation: Base Effects Are Dead, Long Live Base Effects

Though warned for months, many still suffered from "sticker shock" watching the huge jump in prices in May. The Consumer Price Index (CPI) jumped by 0.6% over April, reaching 5.0% year-over-year, its highest rate since August 2008. Core CPI, excluding food and fuel, also climbed by 0.7% over April, reaching 3.8% year-over-year, its highest rate in 29 years. As expected, the base effects explain part of the price gains, and will soon fade as the impact from pandemic-depressed prices filter out of the system. More importantly, prices in many other sectors are experiencing a hefty near-term boost in prices from supply and labor bottlenecks as business activity catches up to the reopening demand surge. The bigger question is over how long these price pressures will last.

The supply chain disruption is best explained through the huge price gains in used car sales. Household preferences over transportation during the pandemic shifted toward owning a car, which was seen as a safer form of transportation relative to public transport. Together with a sizable stimulus check and low interest rates, demand surged for new and used cars. Since households were also quarantined, demand for electronics, which also use semiconductors, picked up significantly as well. The global shortage of semiconductors restricted auto manufacturing, cutting the supply of new cars. Concerns over replacement costs led rental car agencies to hold onto their used cars longer, reducing the available stock of used cars. These factors led to supply constraints in the auto market, and as demand overpowered supply, the result was much higher prices. We believe that once the semiconductor industry works through supply chain stoppages, price will ease, illustrating what the Fed calls "transitory" price increases.

However, possibly recognizing that the timing is uncertain, and moreover the price gains may be "sticky" going down, the Fed adjusted the phrase to now say "largely transitory". Fortunately, there already are some signs of cooling, albeit by small amounts after a significant run up. Both market and survey medium- and long-term inflation expectation measures eased in June, despite the jump in May CPI and Producer Price Index readings. According to a recent Bank of America survey of fund managers, 72% of fund managers believe inflation is transitory. This is in line with a recent survey of S&P Global Ratings corporate analysts, which indicated that "input prices will be largely manageable this year from businesses' perspective" and "most corporate sectors expect the current pressure to moderate, as pandemic-related disruptions lessen, the economic recovery unfolds, and productivity and efficiency continue to improve" (see "U.S. Markets See Inflationary Ghosts; Macroeconomic Signs Disagree" April 12, 2021).

Chart 6

The FOMC statement and press conference on June 16 address the stronger economic recovery head on, with the statement starting, "progress on vaccinations has reduced the spread of COVID-19 in the United States. Amid this progress and strong policy support, indicators of economic activity and employment have strengthened." This is much stronger than the April 28 FOMC statement opener: "The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world. Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened." The June statement paved the way for markets to absorb the Fed's much more optimistic economic outlook. The FOMC dot plot now indicates that more FOMC members believe they will have to address the pickup in economic activity and acceleration in prices sooner than they thought in April.

The Fed finally broached the quantitative easing elephant in the room, in a roundabout way, when Powell said during his press conference that June was "a talking about talking about meeting." He pretty much confirmed what the new dot plot showed, more policymakers are ready to address the boost in economic activity and price gains, though he cautioned markets to take the dots "with a grain of salt." He also was clear to note that a rate hike was not on the table any time soon. The dot plot was clear on that point as well. The dot plot now indicated that the median expectation of policymakers is that the first Fed rate hike will be in 2023 (previously 2024), with another one following that same year. We continue to expect the Fed to raise rates for the first time in 2023, though we moved it the first quarter, with another hike expected in third-quarter 2023. We expect two more rate hikes in 2024, with year-end 2024 at 1.12%.

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.

Chart 7

Upside: Summertime Dream

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 earlier thought. Households, itching to go out and celebrate with friends and family, dip into their savings accounts to splurge on the leisure activities they have neglected for most of the year. Consumer spending surges to a post-World War II high of 8.8% in 2021 and 5.0% the following year, above the 8.1% and 4.1% rates seen in the baseline.

As future economic conditions continue to suggest happy days and more revenue in store, businesses readily open up their bank accounts. Equipment spending surges by 15.2% and 3.8% this year and the next, with relative gains over the baseline increasing in 2022 as confidence improves. In the upside scenario, the U.S. economy rebounds 7.3% in 2021. It continues to grow at a higher pace of 4.7% in 2022 versus our baseline.

Higher growth rates also mean the unemployment rate falls under 4% by mid-2022 and core CPI inflation (actual and expectations), after slowing once the "transitory" shocks subside, head higher in 2022, averaging 2% consistently on a 12-month-rolling average basis starting in early 2022. The Fed raises its policy rate for the first time in this recovery in late 2022 (versus early 2023 in baseline).

Table 3

Downside: Summertime Blues

In our pessimistic scenario, the economy still grows at a 6.0% annual average pace in 2021, faster than our prestimulus baseline growth of 4.2% published in December. In other times this may be impressive, but in today's context of 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 new strains of the virus keeps consumers cautious. Businesses start opening and nonresidential investment picks up, but not as much as in our baseline. The S&P500 index barely moves up while employment improves slower compared to our baseline. The impact of government stimulus and spillover effects display multiplier impacts near the lower end of historical experience. The stimulus-driven pickup in demand is felt, but only half-heartedly.

In such a scenario, the unemployment rate doesn't get back under 4% till 2024. After the base effect runs out in the first half of 2021, supply chain disruptions keep inflation above the Fed's average target of 2% into 2022, only to deteriorate to levels well below the Fed's 2% target rate through 2024. With this backdrop, the Fed is in no rush to lift rates through 2024, despite the unemployment rate finally reaching pre-COVID levels in 2024

Table 4