Five flashpoints to watch for in 2021 economy

The U.S. financial system has held strong through the first 10 months of the pandemic thanks in part to an unprecedented federal response and the unique nature of the coronavirus recession. 

While the economy remains deeply damaged and far from a full recovery, early concerns about frozen bond markets and plummeting stocks have largely been left behind.

Even so, 2021 may hold new risks driven by the uncertain future of the economy and federal aid.

Sky-high stocks

The stock market was among the first sectors of the economy hit by the pandemic and the first to totally recover from its early economic chaos. While the share prices of companies in hard-hit sectors remain low, rallying tech stocks and a rebound across other industries unfettered by the pandemic pushed major stock indexes to record heights.

Another coronavirus-level crash is unlikely barring a massive economic or health setback. But some experts say investors are already positioning for volatility in January, due in part to the Georgia runoff elections that will determine which party controls the Senate.

“The marketplace is indicating more uncertainty as we head into the New Year. It is not often that you see most of the major indexes setting new all-time highs and VIX index settling in the 21% to 24% range,” wrote Brian Overby, Senior Options Analyst for Ally Invest, referring to an index that rises when the stock market is volatile.

Soaring housing prices 

Ultra-low interest rates and months of teleworking have prompted a surge in home purchases and sale prices.

Demand for housing has strained a dwindling supply of available homes, pushing median listing prices 13.3 percent higher than in 2019. Construction on more than 1.5 million homes began in November, and building permits rose to their highest level since September 2006.

Tighter lending standards have kept banks from making the same subprime loans that fueled the housing bubble collapse before the financial crisis in 2007 that sparked the Great Recession. But the uncertain path of the economy and the massive gulf between homeowners and struggling renters means those prices could face pressure come 2021.

Looming foreclosure and eviction crisis

As millions of Americans have flocked to new homes, millions more are facing homelessness in 2021. The federal government has enacted several foreclosure and eviction protections to keep Americans in their homes through the end of 2020, but several of those are set to expire by the end of January without further action.

Experts estimate that tens of millions of households could face eviction or foreclosure when those protections expire, and the inability to pay rent due in 2020 could cost millions more their homes.

Not only would that be an economic calamity, but massive losses taken by mortgage servicers could ripple through the financial system.

“In different circumstances, the large-scale delinquencies and defaults we saw last spring could have caused some mortgage companies to fail, especially if the surge in origination and refinancing income had not materialized,” said Federal Reserve Governor Michelle Bowman in a speech last month.

Commercial real estate woes

The uncertain pace of the recovery and the widespread adoption of remote work poses serious challenges for commercial real estate.

Nearly a year of teleworking has made some eager to return to the office, but industry experts say that many companies are already making decisions to scale down office space, seek buildings in cheaper areas or eliminate their physical footprint all together.

“Property segments that don’t require face-to-face interaction, like data centers, cell towers and logistics facilities, recovered quickly from the initial shock of the pandemic last spring and have benefitted from a socially distanced, work-and-shop-from-home economy that has created strong demand for digital communications and e-commerce services,” wrote Calvin Schnure, senior economist at Nareit.

“Most traditional property types … however, have experienced rising vacancy rates, falling rents or both,” he added.

Banks facing loan losses

Banks spent the first six months of 2020 boosting their provisions for credit losses, the amount of money set aside to cover loans that won’t be repaid. The Federal Reserve was confident enough in the ability of banks to weather whatever 2021 holds that Friday it allowed the largest banks it supervises to pay dividends to shareholders again after implementing a freeze earlier this year.

Even so, Federal Reserve Governor Lael Brainard voted against the decision, arguing that “prudence would call for more modest payouts to preserve lending to households and borrowers during an exceptionally challenging winter.”

Fellow liberals fear the Fed could be acting too quickly and preventing banks from keeping enough on hand to back up losses if the economy turns south in 2021.