US Economics Analyst

After Peak Growth: A Slightly Slower Service Sector Recovery (Walker)

Research | Economics | By Jan Hatzius and others
  • As the US economy moves past peak growth, consumer spending will have to rotate from goods to services for the recovery to continue at a robust pace. While total consumption has already rebounded to its pre-pandemic trend, the current composition is unsustainable: goods spending is far above trend, while services spending remains soft.

  • The services categories where spending remains depressed are generally either associated with high virus risk, such as live entertainment events, or connected to office-based work, such as ground transportation or dry cleaners. While consumption patterns might evolve toward other activities over time, in the near term a complete service sector recovery will likely require fully overcoming virus fears and returning to office work patterns. Both now appear likely to take longer than we anticipated.

  • While most consumers appear to be comfortable returning to high-contact services, some are still hesitant. They are likely to remain cautious for now as the spread of the Delta variant keeps covid fears alive, delaying a full recovery.

  • A full return to office work is also likely to take a while. Office attendance in large cities is still just one-third of the pre-pandemic level, job ads increasingly offer remote work, and surveys indicate that both workers and employers expect work from home to remain much more common than before the pandemic. Remote work offers potential productivity advantages and is preferred by some workers, but it is likely to delay the recovery of the office-adjacent economy, which likely implies a lower level of services spending in the near term.

  • We have long expected growth to peak in a mid-year boom fueled by vaccination and fiscal support. But the subsequent deceleration now looks likely to be a bit sharper because the goods-to-services rotation is likely to be less seamless. We have therefore lowered our 2021H2 consumption growth forecast, resulting in 1pp downgrades to our GDP growth forecasts for Q3 (to +8.5%, vs. +7.1% consensus) and Q4 (to +5.0%, vs. +5.1% consensus). This leaves our 2021 growth forecast at +6.6% on a full-year basis (vs. +6.6% consensus) or +7.0% on a Q4/Q4 basis (vs. +7.0% consensus). We expect growth to slow further to a trend-like 1.5-2% by 2022H2, a sharper deceleration than consensus expects.

After Peak Growth: A Slightly Slower Service Sector Recovery

It took just one year for consumption to recover to the pre-pandemic trend following the deepest recession since at least World War II (Exhibit 1, left). But the current composition of consumer spending is unsustainable: goods spending is far above trend, while services spending remains soft (Exhibit 1, right). As the boost to demand for goods from stimulus checks and pandemic preference shifts fades, the burden to carry the recovery forward is shifting to the service sector. In this week’s Analyst, we look at the reasons why services spending has not yet fully bounced back, the scope and timeline for a full rebound, and the implications for the growth outlook.

Exhibit 1: Consumer Spending Has Fully Rebounded to the Pre-Pandemic Trend, Driven by a Surge in Goods Spending That Is Likely to Fade Soon

Source: Opportunity Insights, Second Measure Data Points Blog, 1010data, Department of Commerce

What’s Holding Back Spending on Services?

The majority of services categories are well on the way to recovery. Even some high-contact activities such as gyms (96% of the Feb. 2020 level), casino gambling (99%), and food services (100%) that fell sharply at the start of the pandemic are not far from fully recovering to trend.

However, there are a number of services categories, most of which account for more modest shares of total consumption, that remain quite depressed (Exhibit 2). These categories are generally either associated with large crowds and high virus risk, such as live entertainment events and amusement parks, or connected to office-based work, such as dry cleaning and child care.

Exhibit 2: Spending Remains Significantly Depressed in Services Categories That Have Very High Virus Risk or Are Connected to Office-Based Work

Source: Department of Commerce, Goldman Sachs Global Investment Research

A Slightly Longer Road to Service Sector Recovery

While consumption patterns might evolve toward other activities over time, in the near-term a complete service sector recovery will likely require fully overcoming virus fears and returning to normal office work patterns. Both now appear likely to take somewhat longer than we anticipated.

While most American adults are now vaccinated and most consumers appear to be comfortable returning to high-contact services, some are still hesitant. Both vaccinated and unvaccinated individuals have varying perceptions of remaining virus risk, resulting in a wide range of tolerance levels for re-engaging with high-contact services. In some cases, business operators are also voluntarily imposing their own restrictions such as requiring proof of vaccination or imposing capacity limits, reflecting both their own concerns about virus spread and their customers’ concerns. In short, it is increasingly clear that while mass vaccination has had a huge impact on service sector activity, it is unrealistic to expect virus fears to instantly disappear entirely.

The Delta variant is likely to keep covid fears alive a little longer, delaying a full recovery. We do not expect the Delta variant to pose much downside risk to service sector activity relative to current levels, for a few reasons: appetite for new government-mandated restrictions appears low; early state-level evidence shows little impact on consumer spending so far; and the virus situation already appears to be improving in the United Kingdom and other countries where it spread earliest. However, the Delta variant might push back the date when existing government or business restrictions are fully relaxed.

The timeline for a full return to office work patterns also now looks somewhat longer. Office occupancy data from Kastle Systems (Exhibit 3, left) shows that office attendance in large cities is still just one-third of the pre-pandemic level, and our REITs analysts’ office survey reached a similar conclusion. While there is some variation by city, even the large cities in Texas with the highest levels of return to office have only seen attendance reach half of its pre-pandemic level (Exhibit 3, right).

Exhibit 3: Office Attendance Remains at Just One-Third of the Pre-Pandemic Level in Major Cities

Source: Kastle Systems

Surveys indicate that both workers and employers expect work from home to remain much more common than before the pandemic. While the physical presence of workers is essential in much of the goods sector and in some consumer-facing services, the pandemic revealed that remote computing was a surprisingly viable alternative in many other parts of the economy. Analyzing the labor market in the spring lockdowns last year, the Bureau of Labor Statistics found that 46% of workers were able to telework, much higher than the pre-crisis norm of 7%.[1]

Surveys indicate that both workers and employers expect work from home to remain much more common than before the pandemic. The survey results summarized in Exhibit 4 imply that roughly a third of the workforce would be willing and able to work from home at least some of the time. About one-fourth of workers expect to be able to work remotely after the pandemic, and about one-fourth of employers expect to allow their employees to work remotely. These survey estimates have tended to decline recently; for example, our REITs analysts’ office survey from just last month indicates that 19% of employees now expect to work remotely, versus 27% a couple of months earlier. Even so, the share is likely to remain high for some time, and the new equilibrium is likely to feature much more remote work than before the pandemic.

Exhibit 4: Both Employers and Workers Expect Remote Work to Remain Much More Common in the Future

Source: Department of Labor, Goldman Sachs Global Investment Research

Job advertisements provide further evidence that remote work is likely to persist. Using data on individual job listings and descriptions from LinkUp, we estimate that over 7% of new jobs listed in June offered remote working options (Exhibit 5), well above the pre-pandemic norm of roughly 1%.

Exhibit 5: Employers Are Increasingly Hiring for Remote Work, Signaling a Lasting Shift

Source: LinkUp, Goldman Sachs Global Investment Research

Remote work offers potential productivity advantages by allowing workers to save money and time spent on commuting, and some workers clearly prefer their new work arrangement.

But greater remote work is likely to delay the recovery of the office-adjacent economy, which implies a lower level of services spending in the near term. Workers who commute to an office, for example, might consume transportation services to and from the office, restaurant meals during lunch, work-appropriate apparel and dry cleaning services, and other goods and services they pass by during their time away from home. Remote workers need to eat too, of course, and they might be as or more content preparing their own meals or wearing casual clothing at home, but in the eyes of the GDP statistics, this new arrangement is likely to mean less market-transacted economic activity.

As an example of this, Exhibit 6 shows that food services employment remains substantially lower in the cities that have been slower to return to the office, and this remains true even if we control for state-level virus restrictions, the local share of office employment, or the current level of overall local consumer spending. In the case of food services, former office workers could reallocate some or all of their office lunch budget to food services near their homes, but for some office-adjacent services, such as transportation services used for commuting, there are not substitutes.

Exhibit 6: An Incomplete Return to Office Has Substantial Negative Spillovers to Surrounding Businesses

Source: Kastle Systems, Department of Labor, Goldman Sachs Global Investment Research

A Slower Goods-to-Services Rotation Means a Slightly Sharper Growth Deceleration

We have long expected growth to peak in a mid-year boom fueled by vaccination and fiscal support. On a monthly basis this view implied that growth would be strongest over the last several months, and on a quarterly basis it meant that the stronger quarters would be Q2 and — in part because of the statistical hangover in the quarter-on-quarter growth rate — Q3.

We still expect continued recovery in demand for services to more than offset a partial normalization of demand for goods from current elevated levels (Exhibit 7), keeping total consumption on an upward trajectory relative to the pre-pandemic trend. But the goods-to-services rotation now looks likely to be less seamless than we had previously assumed. As a result, the coming growth deceleration now looks likely to be a bit sharper than we had anticipated.

Exhibit 7: We Have Lowered Our Consumption Forecasts Slightly But Still Expect Rising Demand for Services to More Than Offset Normalization of Demand for Goods

Source: Department of Commerce, Goldman Sachs Global Investment Research

We have lowered our consumption growth forecast for the second half of the year to +5.5% and +3.5% in Q3 and Q4 (QoQ ar, vs. +7.5% and +5.5% previously). This downgrade is partly offset by a somewhat stronger outlook for inventory accumulation in the back half of the year after ongoing supply chain disruptions led to a very large drawdown in Q2. Taking these considerations on board, we have lowered our GDP growth forecasts to +8.5% in Q3 (vs. +9.5% previously and +7.1% consensus) and +5.0% in Q4 (vs. +6.0% previously and +5.1% consensus). This leaves our 2021 growth forecast at +6.6% on a full-year basis (vs. +6.6% consensus) or +7.0% on a Q4/Q4 basis (vs. +7.0% consensus).

Until a couple of months ago, our GDP growth forecast had been distinguished for the prior year by being well above consensus expectations, reflecting our optimistic view of the prospects for an early vaccination timeline and a strong economic recovery. But at this point, our forecast is instead distinguished from consensus expectations by the sharpness of the deceleration that we expect over the next year and a half, from 8.25%/8.5% during the Q2/Q3 mid-year boom all the way down to a trend-like 1.5-2% by 2022H2 (Exhibit 8).

Exhibit 8: After GDP Growth Peaks in Mid-2021, We Expect a Sharper Deceleration Than Consensus to a Trend-Like 1.5-2% in 2022H2

Source: Bloomberg, Goldman Sachs Global Investment Research

Corresponding to the downgrade to our growth forecast, we have also bumped up our unemployment rate forecast slightly from 4.2% to 4.4% at end-2021. We expect to learn considerably more about the prospects for labor market recovery from the July employment report, which should provide a test of the impact of seasonal adjustment irregularities and the early expiration of federal unemployment benefits in some states.

Ronnie Walker

The US Economic and Financial Outlook

Source: Goldman Sachs Global Investment Research

Economic Releases

Source: Bloomberg, Goldman Sachs Global Investment Research

1 ^ Matthew Dey, Harley Frazis, Mark Loewenstein, and Hugette Sun, "Ability to Work From Home: Evidence From Two Surveys and Implications for the Labor Market in the COVID-19 Pandemic," 2020.

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