A deep short recession?

Data last week continued to support our general view on the trajectory for the economy: a deep, short recession followed by a long, tough recovery. Retail sales data for May surprised on the upside following an acute pullback in spending in April. With stores reopening in parts of the country after a period of shutdown, consumers released pent-up demand. Sales grew strongly across subcategories as consumers reengaged with physical retail space. Yet, sales levels remain down significantly from February’s levels, indicating a long road back to previous peak retail sales levels.

Industrial production also grew in May, following significant declines in March and April. Production rebounded broadly, across both durable and nondurable goods, with the economy moving past its technical trough in April. The opening of the economy and relaxation of social distancing standards should support further growth over the next few quarters.  But like retail sales, a welcome rebound does not mask the long, difficult path ahead in order to recover significant lost production.

Housing starts and building permits also increased in May after declining following the initial stages of the lockdown. Homebuilder confidence recently rebounded amidst signs of a limited downturn in the housing industry. Although housing metrics remain well below pre-pandemic levels, continued strong demand for housing, limited inventory for sale or rent, and low interest rates should provide a boost to the housing sector. Unlike the previous downtown, which centered on the residential real estate market in the U.S., housing could lead the economy into recovery. That would mark a return to a more typical performance for the industry.

Initial unemployment claims declined again for the 11^th straight week while continued claims declined for the second consecutive week. Both metrics remain at elevated levels, a sign of ongoing disruption and providing a mixed view of the labor market. Layoffs are declining and hiring is resuming. But at this juncture such elevated levels of both metrics mean that some layoffs are becoming permanent, which will make reobtaining work more difficult than for those on temporary layoffs.

While the view on trajectory for the economy is becoming more apparent, risks abound. If the outbreak of the pandemic reaccelerates, some government officials could reimplement lockdowns and shutdowns which would damage the recovery. Even if governments do not take such actions, consumers could still refrain from economic activity out of fear for their health or because the illness itself incapacitates them. And we remain vigilant about “cliff austerity”: if fiscal stimulus from the federal government expires or gets reduced after the end of July, that could remove a vital support for the economy. Government spending is currently supporting millions of consumers, businesses, and jobs. Removing it (or a meaningful portion of it) too abruptly could risk any nascent recovery over the next couple of quarters.