New York CNN Business  — 

The pandemic is intensifying, statewide curfews are back and Washington is asleep at the wheel. This toxic backdrop is derailing the US economic recovery just as Joe Biden prepares to take charge — and JPMorgan is warning the economy is in fact about to shrink.

On Friday, JPMorgan became the first Wall Street bank to warn that GDP will turn negative by early next year as Americans wait for vaccines to get distributed.

“This winter will be grim,” JPMorgan economists wrote in a client note, “and we believe the economy will contract again” in the first quarter.

After blockbuster growth this summer, the economy is rapidly losing momentum. The third quarter brought a record 33.1% annualized growth, but now JPMorgan expects GDP to slow to 2.8% in the fourth quarter and then shrink by 1% during the first three months of 2021.

Covid-19 infections have skyrocketed to record highs, forcing the return of dreaded health restrictions: New York City public schools shut down again this week, California and Ohio issued statewide curfews and even the National Zoo is closing again. All of these steps will add pressure to the US economy.

‘Dereliction of duty’

The federal government can’t agree on how to treat the renewed economic weakness. Republicans and Democrats have repeatedly failed to reach a deal on new fiscal relief, setting up a scenario where 12 million Americans could lose benefits by the end of the year.

“Congress has failed the country,” said David Kotok, chief investment officer of Cumberland Advisors.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, slammed Congress for an “appalling dereliction of duty.”

The Treasury Department added to the mess Thursday by yanking $455 billion of funds the Federal Reserve was using for emergency lending programs. The Fed issued a statement opposing the move, marking a rare public dispute between the central bank and Treasury Department -— in the middle of a crisis, no less.

Treasury Secretary Steven Mnuchin said those funds can be used by Congress to stimulate the economy, but there’s no guarantee a deal can be reached there. And this is a bizarre time to remove ammo the Fed is using to fight the crisis.

“Trump would have signed a bill pre-election. Now he is unpredictable and our national government seems to be in chaos,” Kotok said.

Even the US Chamber of Commerce, a normally Republican-friendly organization, said Mnuchin’s decision “closes the door on important liquidity options for businesses at a time when they need them most,” adding that it “unnecessarily ties the hands of the incoming administration.”

Light at the end of the tunnel

The good news is that medical breakthroughs suggest the economic revival could get back on track later next year. Both Pfizer (PFE) and Moderna (MRNA) have announced early results indicating their vaccine candidates are about 95% effective — far more than experts had anticipated.

Although it will take time to distribute those vaccines, they should eventually bring relief to the parts of the economy crushed by the pandemic: hotels, airlines, cruise lines, restaurants and movie theaters.

“The early success of some major vaccine trials increases our confidence that such medical intervention can limit the damage that the virus has inflicted on the US economy,” JPMorgan economists wrote.

JPMorgan expects the economy to grow “briskly” during the second and third quarters, with annualized growth of 4.5% and 6.5%, respectively.

Of course, some parts of the US economy are outright booming.

Fueled by extraordinarily low mortgage rates and a rush to the suburbs, US home sales surged in October to the highest level since the bubble peak in 2006.

The strength of the housing market helps to blunt the broader economic troubles caused by the pandemic.

Consumer spending slows, layoffs rise

Still, there are growing signs the worsening spread of Covid-19 is hitting the US economy.

Retail sales barely grew in October, and for the first time since April spending at bars and restaurants declined. As the CNN Business Economic Recovery Dashboard shows, restaurant reservations on OpenTable peaked in mid-October and are down by more than half from a year ago.

“The restaurant recovery ground to a halt in October,” said Pantheon’s Shepherdson.

Target (TGT), one of the nation’s largest retailers, had a blowout third quarter but warned the pandemic and economy pose real risks going forward.

Raphael Bostic, the president of the Atlanta Federal Reserve, said on CNBC this week that officials are going to be “paying really close attention” to see if the “weakness” in retail spending turns into something worse.

Meanwhile, the labor market recovery is losing steam – and will be pressured by the new travel restrictions. Initial jobless claims rose in the latest week for the first time in a month. At 746,000, first-time unemployment claims remain well above the worst levels of the Great Recession.

The US economy has shown surprising resilience – until the last few weeks.

But now Aneta Markowska, chief financial economist at Jefferies, fears latest coronavirus spike and health restrictions will cause US consumer spending, the biggest driver of the economy, to drop to zero in the fourth quarter.

“There is a real risk we could contract,” Markowska said.

Scarring fears

Wall Street is largely unfazed by the economic slowdown. The Dow is flirting with 30,000 and the S&P 500 is on track for one of its best months in history. Investors are piling into stocks that will benefit from the vaccine.

“If you’re an investor with a long-term horizon, you can look through this near-term weakness,” Markowska said. “If you’re an employee in a COVID-sensitive sector, the vaccines don’t help you yet in any way, shape or form.”

The unprecedented initial response by the Fed, Congress and the White House was aimed at limiting the pandemic’s permanent economic damage. Officials sought to avoid bankruptcies, business closures and permanent job losses.

JPMorgan, however, said the spike in the number of permanent job losses is a “worrisome development” because it can take those newly unemployed longer to find work, plus they run the risk of running out of unemployment benefits.

The hope is that a faster recovery in 2021 limits the scars to the economy. Even so, “some lasting damage still seems inevitable,” JPMorgan said.