As we consider what may happen in 2021, it’s useful to reflect on how we ended 2020—both the good and the bad. The election is behind us, which is good news. The bad news is that the transition has yet to start, and the results remain disputed by the White House. Turning to the coronavirus, the good news is that the first of the vaccines looks to be more effective than anyone expected. The bad news is that the third wave of the pandemic continues to worsen throughout the country. On the economic front, the good news is that jobs and confidence are holding up surprisingly well. The bad news is that many people will face a financial cliff at the end of the year, as subsidies expire and as eviction and foreclosure bans end. To sum it all up, it is the best of times—and the worst of times.
Markets seem to be banking on the best-of-times scenario. They ran up sharply in the aftermath of the election. And as of mid-November, markets were at or close to all-time highs. This movement does reflect a good deal of optimism, which is not unwarranted. After all, most of the worst news is backward facing, while most of the best news looks forward. Of course, there are real risks. But what matters to the economy and markets are the trends at any given time, and a surprising number of those trends are positive.
In an environment where so much is happening, it’s hard to predict what might happen in the year ahead. There is a lot we do not know, so outcomes remain uncertain. At the same time, we do know enough to make some educated guesses about the likely course of events. Just as important, we can identify the most critical components of those guesses. Right now, this approach is the best one we can take.
With that in mind, this 2021 outlook will outline what I see as the most probable course of events. It will also detail which factors may lead to different outcomes. My goal is to provide a reasonable basis for planning, as well as the context for when those likely outcomes become much less likely.
Let’s start the discussion with the coronavirus pandemic, as this will drive all other outcomes. We’ll then walk through the economic and financial implications of the pandemic.
The Coronavirus: Can the Third Wave Be Contained?
The first question we should ask is, “Will we get the third wave under control?” The answer to this one is easy: yes, we will. The more difficult question is, “When?” The third wave, now underway, is already more severe and likely to be longer lasting than the prior two waves. The risks in the short term are real.
Fortunately, we know how to control the spread of the virus. We also know the source of the current outbreaks: a lack of social distancing and mask wearing. When those conditions change, the spread rate will decline as it did in previous waves. Plus, there are already signs that preventive measures are starting. In Utah, for example, a state-wide mask order and limited lockdown have been ordered. In Minnesota, restrictions are moving into place. Other cities and states will likely move to consider similar measures as well.
As we saw in the prior two waves, rising infections create the political conditions needed to support policies (e.g., masks and lockdowns). The states with the highest infection rates are now approaching the levels seen in New York and New Jersey in the first wave. Once restrictions are in place, we should see infection rates trend down. Although it may take longer for those rates to decline than in the prior waves, the virus should be brought under control in the first half of the year.
By that time, we should also see vaccines becoming widely available. This will further act to control the spread. At this point, it is reasonable to estimate that by the second half of 2021, the risk of outbreaks and shutdowns will largely have passed.
The Economy: Renewed Growth Ahead?
The question now becomes what that outcome means for the economy in 2021. Here, we have learned quite a bit. Looking back over the first half of 2020, it is clear that we can largely write it off. But the second half saw the economy start to adapt to pandemic conditions and return to growth.
The rebound in job growth was strong at first, and it remained well above pre-pandemic levels after that initial rebound. This trend suggests that healing continued even as the third wave exploded. Further, while layoffs remain high, they have been steadily trending down as companies adapt to the new conditions. With the job market continuing to improve, consumer confidence and spending have also started to recover. Finally, business confidence remains above the 2019 levels, and investment has been strong. From an economic perspective, substantial damage was certainly done. Still, the healing process has moved and continues to move along. As such, we could expect a return to normal by the end of 2021.
Here, too, there are signs of upside risk. The recovery at the end of 2020 occurred despite some obstacles. Chief among them were the third wave of the pandemic and the end of governmental stimulus and subsidy programs (including expanded unemployment insurance). With the election over, both sides are now talking about another round of stimulus. As the third wave subsides next year, that stimulus could help the economy recover even faster. The economy has kept improving despite the headwinds of recent months. If those headwinds fade, we should see an even faster recovery.
What that means for 2021 depends on how quickly the recovery continues. To figure that out, we need to look at the four key elements of the economy: consumer spending, business investment, net exports, and government spending.
Consumer spending. When we talk about consumer spending, we need to talk about jobs and confidence. Let’s start with jobs.
The job losses in March and April—about 22 million—were unheard of. Since that time, we’ve also seen an unprecedented recovery in employment, almost 11 million jobs created. We are now halfway back to where we started from. Plus, the past months have been adding jobs at a rate of about 600,000 per month.
The sheer magnitude of the losses and the recovery so far reveals this has not been a normal economic recession. Rather, it’s been a policy recession. The mandated economic shutdown drove the job losses. Retail and hospitality workers were hit especially hard, as public-facing jobs were disproportionately affected. But when the economy started to reopen, this drove the job gains. These facts give us a context from which to consider what the recovery through 2021 may look like.
For at least part of that time, we are likely to see the third wave continue. Given that, using the job gains for the past two months seems a reasonable metric. The average gain is about 650,000 per month, a fraction of the job growth over the prior months. As such, this is a reasonably conservative estimate of job growth going forward. It reflects an expanding pandemic but also an adapting economy.
With jobs now 10.1 million below their peak, that would imply a full recovery period of about 16 months. So, at current rates of job growth, employment would be back to the pre-pandemic peak by early 2022. If the medical news improves as expected—which a combination of policy measures and a rollout of vaccines should ensure—we could see employment recover by the end of 2021.
The improving employment climate has also helped support confidence. Despite the third wave, present-situation confidence has recovered substantially (see Figure 2). While expectations for six months out are down a bit, they still indicate continued recovery. In turn, this confidence would generate faster consumer spending growth. If jobs continue to recover, there is also the possibility for a faster or higher recovery in present-situation confidence. In either case, a recovery to levels that would support consumer spending growth is very possible.
Business investment. Business confidence is reported in diffusion indices. Here, anything above 50 is expansion and anything below 50 is contraction. The service and manufacturing sectors showed sharp drops into contraction in the early days of the pandemic. They have since recovered to strong expansionary levels.
Indeed, the bounce in May and June was good news. It took business confidence for the service and manufacturing sectors from the lowest levels in the past 10 years back into expansion. Now, service and manufacturing confidence levels are well above both pre-pandemic levels and even the levels in 2019. As of the end of 2020, business is feeling much better about next year.
What if we compare changes in business confidence with changes in business investment? It reveals we can expect to see business investment continue to improve into next year (see Figure 4). Given the ongoing adaptation of the economy to the pandemic and the likely availability of vaccines in 2021, we may see it speed up further and return to something like normal early next year.
Last, but not least, interest rate levels affect consumer spending and business investment. As such, they are a major economic risk indicator in their own right. The Federal Reserve (Fed) recently decided to maintain rates at effectively zero. This will continue to provide a significant cushion to the economy, as designed, by holding rates down across the yield curve. Despite the low-rate policy, the gap between the 10-year and 3-month Treasury securities has now risen toward the level that historically has signaled the end of a recession, despite Fed policy aimed at keeping rates low. The important detail here is that when the gap climbs to this point after a reversion, the market is pricing in the recovery after the recession—typically within the next two to three quarters. So, lower rates are signaling a recovery early next year.