An improving prognosis

Measures being taken now are setting the stage for better times in 2021, through the middle of this decade

February 18, 2021
>> Quick takes:
  • Overall prognosis continues to improve
  • Economy continues to heal through early 2021
  • Yet, powerful remedies still needed
  • Condition should upgrade by roughly mid-year
  • Improved outlook provides good therapy for CRE

Sometimes, change occurs so gradually it feels imperceptible, as if things remain static. This impacts not only one’s assessment of the present situation, but the future as well. We see this kind of change at work right now in the U.S. economy. Marginally, and quietly, the U.S. is experiencing change that should set the stage for economic outperformance relative not only to U.S. potential growth, but to most other developed economies. While not overlooking the significant and seemingly contradictory current challenges presented by the ongoing pandemic, our projections see through this to the underlying changes.

…” setting the stage for not only better times in 2021, but through the middle of this decade.”

Those improvements are setting the stage for not only better times in 2021, but through the middle of this decade. While the situation with the pandemic will restrain the economy in the first half of 2021, it should still outperform much of the rest of the world. After mid-year, when we expect the U.S. to reach widespread immunity (primarily via vaccination and secondarily via active immunity), growth should accelerate in a pronounced fashion and bring 2021 real GDP growth near 5% in our base case. 


The economy continued its recovery during the latter stages of 2020. Fourth quarter GDP growth of 4% came in just below our expectations. With that, growth during 2020 registered -3.5%, 100 basis points (bps) worse than 2009 and the worst calendar year since 1946 when the U.S. economy contracted during the demobilization effort at the end of World War II. Yet, the economy experienced a marked improvement as the year progressed. Economic growth rebounded sharply and quickly during the latter half of the year in a break from normal recovery patterns: typically, long recoveries follow deep downturns such as this one. This unusual pattern occurred across several meaningful metrics. Despite the significant contraction in the first half of the year, real GDP ended 2020 down just 2.5% from the 2019 year-end figure, a significant rebound after a peak-to-trough plummet of 10% through mid-year 2020. In the labor market, net job loss totaled roughly 22.4 million in March and April. But during the balance of the year net job gain totaled 12.4 million, approximately 56% of the total loss incurred. And it appears as if momentum extended into early 2021. Though we have limited data thus far through January, the fiscal stimulus passed in late December seems to be supporting struggling households, as intended. None of this serves to minimize the uncertainty or pain that remains in the economy. But as we have emphasized numerous times, the risk to our outlook remains concentrated in the next six or so months until we reach widespread immunity. The median projection from a pool of epidemiologists suggests that we will reach the point of widespread immunity by roughly mid-2021. 

Helpful remedies

What will ultimately heal the economy and get us through this intervening period of uncertainty? Two inveterate remedies and one newer, but more impactful one. First, loose monetary policy continues to support both the real economy and the financial system, the lifeblood of the economy. With policy rates still hovering near zero, the Fed continuing to purchase all sorts of financial instruments, and the Fed’s relatively new stance on dynamic inflation targeting over a cycle (and not as a static benchmark), central bank policy is providing significant support, even though the last few cycles prove that monetary policy cannot serve as a panacea. While not completely out of options, the Fed is doing most of what it can to provide support. 

Second, fiscal policy provided an important shot in the arm in 2020. Occurring in multiple rounds, it has provided critical support, including to households, businesses, state and local governments and health programs. The unprecedentedly large stimulus reflects the severity of the downturn and another of our long-held positions: that the economy cannot self-correct until we move past the pandemic, making fiscal stimulus vital and necessary. Although specifics remain unclear, we still anticipate another round of stimulus to pass by the end of the first quarter, helping to bridge the divide between now and the arrival of widespread immunity which will lead to a more significant economic recovery.  We expect this forthcoming widespread package to provide more support than December’s bill, but less than bills passed during the early stages of the pandemic last year.

Third, vaccination, the fastest path out of health and economic crises, began in late December, even as the pandemic reached its worst point as measured across numerous metrics.  We expect the impact from vaccination to occur in a non-linear, exponential manner. By that we mean initially, the impact seems imperceptible, almost as if they are not occurring. But over time, the benefits accumulate at a greater and greater rate, eventually reaching a point where they are obvious and unmistakable. We already see this process playing out. Although vaccination has been occurring for almost two months, we do not yet see it translating into real economic data. But we know that is coming. The pace of vaccination continues to increase. Although the one-day record of roughly 2.1 million doses occurred on February 6th, recent days have challenged that high watermark, pushing the rolling seven-day average to a new high of roughly 1.7 million doses per day as of February 14th. We expect the daily rate to continue to increase due to a variety of factors including: the opening of more mass vaccination sites, more widespread vaccination at local pharmacies, the ability to extract extra doses from vials, increased manufacturing and greater coordination between state and local governments and the federal government. 

Vaccine doses per day


An upgrade from serious to fair condition

Due to those factors, our base-case outlook forecasts that the economy should continue to grow, and the labor market should continue to gain back net jobs during the first half of this year, reflecting the nonlinear path ahead. Consequently, we will likely avoid a secondary contraction in the economy. This reinforces our view that the technical recession (as measured by real GDP growth) likely ended in mid-2020. Though the National Bureau of Economic Research (NBER) remains the ultimate arbiter of business cycles in the U.S., our base-case outlook suggests that at a minimum we have moved well past the nadir of real GDP. Therefore, we also expect an upgrade in the condition of the economy from serious to fair during this period.

“The economy is sitting on massive pent-up demand…consumers… are sitting on $1.6 trillion of dry powder in the form of excess savings and a deficit of spending during 2020.”

Once the economy reaches that point, its recovery process should rapidly accelerate. The economy is sitting on massive pent-up demand, particularly for services that have remained largely closed, limited, or avoided for safety reasons during the last year. By one estimate, consumers which represent roughly 70% of the economy, are sitting on $1.6 trillion of dry powder in the form of excess savings and a deficit of spending during 2020. While we do not expect all of that to get spent (and certainly not in the latter half of this year) a return to more typical consumption married with the release of this pent-up demand for services, should push real GDP in the latter half of the year well beyond capacity growth rates. This should enable greater job growth, more meaningful inflation and higher interest rates. We do not foresee inflation or interest rates having a detrimental impact on growth in 2021, but we will keep a close eye on both as we project the medium term. We anticipate that the economy will fully recover the GDP lost during the first half of 2020 during the latter half of this year, likely in the third quarter. Forward-looking, soft-data indicators, such as financial markets and sentiment/confidence measures, generally agree with our model’s technical assessment. 

“We anticipate that office-using employment should fully recovery by the end of this year.”

For the labor market, we see a stark contrast between office-using and non-office-using employment ahead. For the office-using segment, vital to the health of the CRE market, its relative outperformance should continue. During the current downturn, office-using employment outperformed the broader labor market (atypical of a downturn) because of the ability of those workers to effectively, if not ideally, work remotely thanks to improvements in technology in recent decades. We anticipate that office-using employment should fully recover by the end of this year. Investment in equipment and intellectual property rebounded strongly in the latter half of the year, improving the current fortunes of office-using workers and setting the stage for continued growth beyond this year. 

Employment, Q4 2019=100


For the non-office using segment of the labor market, we foresee a longer, more tenuous recovery. Although many of those jobs will return as the economy accelerates, many have been lost permanently due to business failures or downsizing of businesses. Although some businesses could return or replace those lost, many services businesses such as restaurants and hotels suffered from excess capacity in many markets in the U.S. before the downturn. Entrepreneurs seem unlikely to rush back to such an oversupply situation, intimating slower growth ahead for jobs in these industries. Some consumers will remain circumspect about partaking in activities (such as dining out), even after widespread vaccination occurs, which will partially restrict the ability of businesses to rehire. Additionally, the investment in equipment and intellectual property which benefits office workers poses greater harm to non-office workers. In short, non-office-using employment looks set to recover, but at a slower pace than office-using employment. 

“…CRE market participants should at least begin thinking about CRE-related decisions, even if they are not yet ready to make those decisions.”

|  Therapy for CRE  |

The relatively rapid rebound in economic activity should provide a needed salve for CRE. Last year, during the worst of the crisis, many forecasted an unusually long, rough road ahead for major property types. But we anticipate that the rebound in economic activity should see a similar effect in the CRE markets. Instead of a prolonged downturn, we foresee something more akin to the typical downturn across property types. Of course, because CRE lags the overall economy, we still anticipate some deterioration in the health of the space market before the situation stabilizes. While this will obviously differ by property type and market, even the laggards should avoid the direst scenarios. For the more forward-looking CRE capital markets, we are already seeing some heartening signs. Not only has sentiment in the market improved, but the market also produced some tentative signs of stabilization during the fourth quarter. Yet with the economy poised to accelerate, particularly later in the year, all CRE market participants should at least begin thinking about CRE-related decisions, even if they are not yet ready to make those decisions. If things evolve as quickly as we think they could, participants who are unwilling to prepare could find themselves behind the curve, missing out on the best opportunities. 

|  Closing Thoughts and Risks  |

Our base case outlook for the economy ranks slightly above consensus. Yet, at every turn since the crisis started, the economy has consistently outperformed the consensus view. We have seen nothing through January that makes us believe this will not persist and we should alter that view. Upside risks remain limited, simply because only so much can be done to increase the speed of vaccination. Downside risks look more pronounced, creating an asymmetrical risk structure around our base case. If vaccination falters, for whatever reason, that would create meaningful downside risk. If variants prove more difficult to inoculate against than currently believed, that would also create notable risk. Yet, these represent short-term risks. No matter how the pandemic and vaccination play out, the medium-run outlook remains very favorable for both the economy and CRE.