The sharpest recession in modern U.S. history is likely over now, and it may wind up being the nation’s briefest downturn ever.

Jeff Greenberg
Senior Markets Economist

Joe Seydl
Senior Markets Economist

Pieter Clerger
Economic Analyst

The sharpest recession in modern U.S. history is likely over now, and it may wind up being the nation’s briefest downturn ever.

Unemployment has surged to levels not seen since the Great Depression and U.S. economic data is anemic in many industries and sectors. However, a range of high frequency indicators (including credit card spending, miles driven and weekly unemployment claims) suggest that the economy’s nadir is behind us and growth has resumed. Indeed, a “great acceleration” already may have propelled us past the early phase of our next business cycle.

But how fast can the economic recovery really be from the coronavirus crisis?  There are few historical pandemic experiences to support a supremely confident prediction. But economic theory and relevant data make us cautiously optimistic that the U.S. economic recovery could be quite rapid, especially when compared to the prolonged recovery that followed the global financial crisis.

There are, in principle, only two types of recessions:

  • Demand recessions are caused by overreach—for example, in the housing sector, corporate investment and stock market.
  • Supply recessions are caused by bottlenecks that have literally choked the economy. Examples of bottlenecks include high interest rates, high energy prices or an impaired supply chain.

Why is this distinction important? Recoveries from supply recessions tend to be much more rapid because, as soon as the bottleneck clears, activity can quickly come back online. The trouble with demand recessions is that the price and credit adjustment process that follows them can take many quarters, even years, to run its full course.

In the United States, the last three recessions were demand recessions and the three before them were supply recessions. This history shows the labor market recovers far more rapidly from supply recessions—about nine times faster, based on the prior six economic recoveries.

This difference matters because, in principle, the recent recession caused by the coronavirus crisis was more of a supply than a demand recession. After all, social distancing is a bottleneck and, before the viral outbreak, neither the household nor the corporate sector was fundamentally imbalanced. Our projections therefore find employment growth could be very rapid over the next two years, assuming everything goes smoothly (and by that we mean no material second wave of COVID-19).

Recoveries from supply recessions tend to be more rapid

Source: Bureau of Labor Statistics, J.P. Morgan Private Bank.
As of May 31, 2020.
The current economic recession is caused by a “social distancing bottleneck” rather than imbalances in the economy. The line chart shows how recoveries from supply recessions caused by bottlenecks are typically faster in bouncing back than demand recessions.

To be sure, the longer the U.S. economy remains closed, the more the macro backdrop could morph into generalized demand weakness, which could lead to a weaker recovery than we expect. However, monetary and fiscal policy are working hard to prevent that dynamic from taking hold. 

So far, weakness in the labor market and bankruptcies in the corporate sector appear concentrated in a few key sectors: leisure and hospitality, retail trade and energy. For the household sector as a whole, spending has collapsed—but not because of income weakness. In fact, the latest data suggest household incomes picked up significantly while shelter-in-place orders were in effect, as incomes were bolstered by increased unemployment insurance payments and fiscal transfers. This meaningful support suggests that pent-up spending by those who were able to save could be quite strong in the second half of this year, when social distancing orders are lifted, provided fiscal policy remains accommodative.

In addition to economic theory, we have empirical evidence from Asia, which is two to three months ahead of the West in relaxing social distancing (even absent a COVID-19 vaccine.) China, in particular, has seen parts of its economy recover rapidly, including its automobile production and sales, housing activity and manufacturing.

To be sure, China’s economy has not completely normalized yet. The services sector is a key laggard. Still, current data signals steady progress is likely, again assuming no resurgence of the virus and renewed shutdowns. China GDP is expected to regain its pre-virus level in the fall of this year, based on the median projection of a survey including 69 economists conducted late May.1

Economic activity in China is quickly improving

Source: China Federation of Logistics and Purchasing, CNBS, China Association of Automobile Manufacturers, China National Bureau of Stastistics. 
The line chart shows how a steep decline in consumer and manufacturing activity in China has been followed by a sharp recovery, demonstrating that economic activity without a vaccine could be feasible.

Where we are in the business cycle has important implications for investments. So where are we now?

A “Great Lockdown” caused the economic downturn. When the recovery gets moving, we’ll likely see a “Great Acceleration” in the economy.

Already there’s been an acceleration of trends like digitization across sectors, as well as of bankruptcies for firms that were teetering before the crisis hit. We have also seen a forceful monetary and fiscal policy response, which lessened the market distress and accelerated the recovery in risk assets. Indeed, we see reason to believe that the “early cycle” period for markets may already be behind us and that we may jump right into “mid-cycle” as the economy recovers.

Mid-cycle implies a recovery is on track, as opposed to the more tentative early cycle in which there are persistent concerns about possibly slipping back into a recession (recall fears in 2011–2012 of a “double dip” recession).

Another key marker of mid-cycle is that companies are not reducing debt but, instead, are at elevated debt levels. U.S. companies, already highly leveraged before the virus outbreak, took on additional debt to survive the shutdown. The starting position of a new cycle is therefore a private corporate sector that has a high degree of leverage and will not be inclined to ramp up borrowing. We do, however, see scope for households to add more leverage in the years ahead, especially given a very accommodative interest rate backdrop that is likely to remain even as the cyclical economy restarts.

Here’s the rub for investors: A recovery that is less tentative and more mid-cycle implies there are fewer bargains. Indeed, broader financial conditions have normalized much more quickly than they did in the wake of the global financial crisis.

Financial conditions are recovering relatively quickly from this crisis

Source: Bloomberg Financial L.P.
As of May 29, 2020.
The line chart shows how March’s market volatility led to a tightening in financial conditions. However, the aggressive monetary and fiscal support has led to a rapid normalization.

For long-term investors, we still believe there are attractive opportunities in risk markets. Even at a more tactical level, there may be further scope for cyclical outperformance in some of the more beaten-down sectors (e.g., consumer and housing oriented).

Still, investment opportunities are not as plentiful as they were just two months ago.

We would be remiss if we did not mention a few key risks on the horizon: the upcoming U.S. presidential election, the politics of passing another fiscal support package, rising U.S.-China tensions and a potential second wave of COVID-19 in the fall.

That said, we currently expect the coming expansion to be similar to the last one in that it will likely be characterized by low and stable inflation, low interest rates and an improving earnings backdrop.

1 “SURVEY REPORT: China Economic Forecasts in May 2020,” by Cynthia Li, Bloomberg, 27 May 2020.