Introduction

Economists have gotten creative in describing recessions and recoveries. We hear talk of V-shaped recoveries where the economy falls and quickly recovers, L-shaped recoveries where the economy falls and remains stagnant, and U-shaped recoveries where the economy falls and requires several quarters before growth returns to normal levels. Some economists have introduced other letters of the alphabet to describe recoveries, bordering on the ridiculous.

Unfortunately, the current recession and recovery are unlikely to be V-shaped. Expect a long, slow recovery taking a year or more before the economy returns to normal. The unemployment rate will take even longer to return to its pre-crisis levels. Loan demand will be tepid with the housing market in a holding pattern. Deposit supply should be healthy as consumers are reluctant to spend and save more of their income.

Unemployment Rate

I believe that the unemployment rate could be as high as 20% for the month of April, with the peak falling in either April or May. At the end of March I said in a blog post that the unemployment rate could reach 15% in April. Since then, initial claims for unemployment insurance have been averaging over 5 million workers per week. In that blog post I mentioned a very simple regression analysis; based on updated data, that model predicts an unemployment rate of as much as 24%. A back-of-the-envelope calculation based on the size of the labor force suggests an unemployment rate almost that high. However, in order to be considered unemployed as measured by the official unemployment rate, one must be “actively” looking for work. Large swaths of the economy have been shut down, and most states have had stay-at-home orders. Many people who have recently lost their jobs have thus not been able to look for work. The unemployment rate to be released this Friday will likely understate the true magnitude. The reading for May unemployment due out June 5th might give a more accurate reading, assuming states begin to reopen in the next couple of weeks.

We know that April and May will be terrible for the job market and the economy as a whole. Third-quarter GDP growth will rebound sharply, but by far less than the second quarter’s fall. Many economists expect second-quarter GDP to fall by 20% to 30% at an annualized rate. As an economist I will admit that most economic models are not calibrated to handle such a massive shock, and forecasting second- and third-quarter GDP is as much a guessing game as a formal exercise.

Here are just some reasons why the recovery will be slow

  1. People will be re-employed much more slowly than they were laid off. In virtually all past recessions, the unemployment rate spikes higher but takes years to return to its pre-recession level. This time the return will be even slower. Even as quarantines are lifted, many people will be hesitant to go out to eat, go shopping in malls, and attend large gatherings. Employers in leisure and hospitality, retail trade, and other industries will be hesitant to expand their workforces until they see demand stabilize. Higher unemployment dampens consumer spending, a key contributor to the economy. Spending on recreation, food services, and accommodations account for 7.5% of GDP.

  2. Realistically, a vaccine against the COVID-19 virus will not be ready until sometime in 2021. Moreover, a known-effective medicine for treating patients will not be available before next year, either. Several drugs are undergoing trials, and last week Gilead Sciences reported its Remdesivir drug did reduce the length of hospitalization required by COVID-19 patients. Double-blind randomized placebo-controlled clinical trials are the gold standard for measuring a drug’s effectiveness, and they often take years to conduct. Even with FDA permissions to accelerate trials, we are unlikely to see a specific treatment for COVID-19 infections this year. Until people are able to get an effective vaccine and know a routine treatment is available, they will exercise extreme caution and avoid crowded areas.

  3. Many small businesses will be closed for good, and the rate of new business formation is too slow for the net number of establishments to snap back quickly. The CARES Act’s Payroll Protection Program (PPP), other legislation, and Federal Reserve programs have established ways in which small and large employers can obtain grants and loans so that businesses could continue to employ workers throughout the crisis. However, not all businesses have been able to apply or get approval for these loans and grants. Moreover, most small businesses inherently have low levels of liquidity and are heavily dependent on sales to fund their operations; they do not have large cash cushions. Many of them will not be able to reopen.

  4. Long-term trends in the retail industry have accelerated in the crisis. Retailer J. Crew filed for bankruptcy protection this past weekend. JCPenny and Neiman Marcus are not far behind. With consumers’ post-crisis hesitance to gather in malls, the already fragile retail industry is in for a rocky road ahead. Spending on clothing and footwear totaled $400 billion in 2019, about 1.9% of GDP.

  5. The travel industry will recover slowly. Tuesday morning British air carrier Virgin Atlantic indicated it thinks the airline industry will take three years to return to pre-crisis levels. Norwegian Cruise Lines is near bankruptcy. Theme parks, resorts, and hotels will operate far below capacity, if it at all, throughout the normally busy summer travel season. In addition to the 7.5% of GDP spent on recreation, food service, and accommodations, transportation services including airlines represent an 2.3% of GDP.

  6. Other industries reliant on travel will also suffer. Whether Cisco Webex and Microsoft Skype meetings are truly as effective as in-person meetings for salespeople, lawyers, consultants, and others is highly debatable (I would say no). Industry conferences and meetings have been cancelled, and few are likely to be held the rest of the year. Metropolitan areas that are reliant on these conferences, Las Vegas being the obvious example, will suffer. Professional services represent 13% of GDP, so even a modest hit to productivity in this industry will have noticeable consequences.

  7. Supply chains will take time to reestablish themselves. As many states gradually lift restrictions, businesses could face both supply disruptions and a hesitance on the part of customers to commit to all but the smallest of orders. The Trump administration has been using harsh rhetoric toward China and could (again) increase tariffs against it. Firms could face the double whammy of weak demand and having to endure higher costs because of tariffs or other measures that force them to seek alternative suppliers. 

  8. The collapse in oil prices will be felt far beyond the oil patch. States heavily dependent on funding tied to oil production, including Oklahoma, North Dakota, Wyoming, New Mexico, and Texas will be under pressure to reduce spending at the state and local government levels. Defaults on debt tied to oil production will be high, putting strain on some banks. Oil and gas extraction only accounts for about 1% of GDP, but in those states the pain will be severe.

  9. The U.S. stock market has recovered more than half the drop from its February high to its March low, but its value remains more than $6 trillion below the high. The wealth effect, which measures how consumers adjusting spending in response to changes in wealth, is between 5 and 10 cents for stock market wealth. If the stock market remains flat for the rest of the year, the wealth effect implies consumption could be $300 to $600 billion below 2019 levels.

Summary

There is no way around it: the economic pain will continue throughout the second quarter. The third quarter will see a rebound, but for many reasons tied to consumer and business confidence, we will revert to the economy’s long-run trend only slowly. Loan growth aside from that associated with the PPP will be tepid as consumers will hesitate to make large purchases and businesses forgo investments. While the unemployment rate will spike higher, deposit supply will remain healthy for a couple of reasons. Higher-wage earners have not been laid off at nearly the rate of lower-wage earners. Spending will be subdued, allowing most households to accumulate savings. Uncertainty in the stock market will cause many savers to seek the safety of FDIC-insured deposits rather than invest in equities.