Economic Recovery

As the U.S. economic recovery stabilizes, supply constraints seem to be the major hurdle to achieving higher growth. Finding U.S. workers will likely remain tough in 2022, weighing on productivity and economic growth. And those workers will cost more.

Our 2021 GDP growth forecast will likely shrink by another 20 basis points to 5.5%--still a 37-year high--after a 1.0 percentage point drop to 5.7% in September. Growth in 2022 will also slip, to 3.9% (was 4.1% in September).

At least 3 million people have exited the labor force since February 2020, according to the Bureau of Labor Statistics (other estimates show an even larger drop in labor participation). That's twice the number of unemployed workers, or almost two-thirds the 4.5 million people not working since February 2020 (see chart 1). The labor participation rate is 61.6%, a 45-year low, 1.7 percentage points below the already low February 2020 rate of 63.3%, and not much better than the 48-year low of 60.2% during the pandemic.

Prime-age workers, ages 25-54, account for 45% of the 3 million people who exited the labor force. Women account for 68% of that 1.4 million. Child care concerns and virus fears for their unvaccinated children under 5 are likely the main factors keeping them out of the job market. The return of prime-wage workers is key to stabilizing the job market. We expect that many of these workers could decide to reenter the workforce, but not until pandemic-related issues are resolved. Retirees account for a smaller share of the 3 million people who exited the labor force since February 2020, though their relative participation rate has dropped a massive 8.1%, over 5x that of prime-age workers.

These enormous job market constraints are crippling business capacity, resulting in much lower economic activity than would be the case if business operations were running smoothly.

We've found that labor supply constraints are largely the result of people exiting the labor force, rather than deciding to remain unemployed and receiving unemployment benefits. How quickly states reopened their economies, not when unemployment benefits expired, largely explained whether people remained unemployed, since most found work once businesses opened their doors. When adjusting the current 4.6% unemployment rate for all the people who left the labor force since February 2020, the adjusted rate is 6.4%, 1.8 percentage points above the headline rate.



How Long Will This Last?

The bigger question is whether the 3 million who left the workforce entirely since the pandemic will return. That depends on how much of the drop is structural and how much is temporary. We estimate that about 42% of the 3 million people who left the workforce since February 2020 are permanent, largely tied to retirement, while 58% are shorter-term, pandemic-specific decisions to leave the market.

Credit Conditions

While credit conditions in the U.S. and Canada remain remarkably favorable for most borrowers S&P Global Ratings rates, several factors have increased the chance that investors will soon seek higher returns—which would lead to an increased cost of capital, particularly for riskier credits. Complicating the matter is a fourth wave of the coronavirus pandemic that has torn through the region and will likely act as a drag on GDP growth through year-end.

In the U.S., inflation continues to run hot, to the degree that real (inflation-adjusted) yields on all corporate bonds have plunged into negative territory for the past several months. Even corporate debt in the ‘B’ ratings category has had negative real yields since June.

Meanwhile, companies are struggling with inflated input costs, as supply constraints persist and unforeseen labor shortages take a toll. This may eat into profit margins, especially for those that find it hard to pass along these costs to customers. This pass-through may become more difficult as the coronavirus delta variant and the end of federal fiscal stimulus (along with the prospect that the Federal Reserve will soon taper its asset purchases) weigh on economic activity and demand.

Beyond inflation, other concerns could push investors into “risk-off” positions—not the least of which are the looming U.S. debt-ceiling crisis and the potential default of property developer China Evergrande Group (CC/Negative/—). While we believe legislators in Washington will work out a compromise to avoid the country’s defaulting on certain payments, authorities in Beijing may face a tougher task.

Market Dynamics

The strong economic rebound in Europe has created several pressures on retail and consumer goods companies. They face higher wages, price rises, shortages of raw materials, and increased costs for freight, packaging, logistics, and energy. While we do expect some squeeze on margins for the sector as a whole, most market leaders and large companies will be able to benefit from higher demand and offset higher input costs from a combination of internal cost-saving measures and selective price rises. A diverse supplier base, bigger order capacity, and superior supply chains and logistics will enable larger companies to gain more competitive advantage based on better product range and availability.

At the other end of the spectrum, highly leveraged companies with weak business risk profiles (35% of rated consumer product companies and 22% of rated retailers) typically have less bargaining power with respect to suppliers and services such as freight. While some regional players holding niche product leadership positions or those with an efficient local supply chains and low overheads will be less impacted, many smaller companies remain vulnerable to significant volatility in operating performance, strong competition, and tough execution amid persistent cost inflation. Many of these companies, still early in the process of recovery from pandemic-related shocks, will struggle to provide a customer experience that can compete with the reach, range, speed, and efficiency of larger players' well-developed global diversified supply chain capability. For these retail and consumer product companies, supply chain and logistical challenges and persistent inflationary headwinds, which we expect will continue into the second half of 2022, will result in margin pressure, slower deleveraging, and lower rating headroom.

Supply Chain Disruptions

The fourth quarter of 2021 will likely look different than the holiday seasons in previous years. This is largely due to the ongoing high-water mark of imports flowing into the U.S. since March. Total imports in March were the highest recorded, an unlikely time for volumes that normally peak in October. The levels reached in March, May and August of just over 3 million twenty-foot equivalent units, combined with freight rates and traffic outside of Los Angeles and Long Beach, Calif., suggest that imports are near their maximum monthly capacity. This is greater than the 2.9 million TEUs recorded in the 2020 peak last October but any company that has not adapted may get stuck in congestion.

Energy and Commodities

Record gas prices have sparked panic in Europe and left policymakers scrambling for answers. Solutions—like bailing out power suppliers, protecting vulnerable retail consumers with state subsidies, or pleading with Russia for more gas—just paper over the cracks. Building strategic gas reserves is a better long-term fix for price stability.

ESG

Vital corporate assets around the world, including factories, transportation networks and power transmission lines, are increasingly in harm’s way as the planet endures a growing number of catastrophic weather events linked to climate change, according to a new analysis by S&P Global Sustainable1.

In a comparison of industries, physical assets owned by the utilities, materials, energy, consumer staples and health care sectors face the greatest danger from the consequences of a warming world between now and 2050, according to S&P Global Trucost data.

Further Reading