Economy Stays in the Game

After deflecting 2005's hard knocks, growth will continue smartly, with more jobs, higher incomes and low inflation.

By Anne Kates Smith, Senior Associate Editor

From Kiplinger's Personal Finance magazine, January 2006

Think of a boxer who takes wallop after wallop but won't stay down. That's the resilient U.S. economy. As we begin the 50th month of economic growth this new year, not too much has changed. You can expect 3% growth in 2006 to follow the 3.6% of 2005 -- an excellent showing considering the massive hurricanes, record oil prices and relentless Federal Reserve Board interest-rate hikes. "We seem to have weathered the actual and figurative storms," says chief economist Nariman Behravesh, of Global Insight, an economic forecasting firm.

Another positive sign: Jobs and incomes are increasing. The U.S. will create two million new jobs in 2006, on top of 1.8 million in 2005, enough to hold the unemployment rate to 5%. With jobs plentiful, employers will add nearly 4% to paychecks -- and your money will stretch. Although gasoline and heating bills are feeding the household inflation meter, prices are falling elsewhere -- such as for new cars and consumer electronics, to name two big items. Following an expected 4% increase in 2005, overall consumer prices will rise 3% in 2006.

And businesses will stay healthy. Corporate America's balance sheets and profit margins are the strongest they've been since the 1960s, with only a few industries, such as airlines and U.S. automakers, in trouble. Homebuilders, however, sense that the boom is fading. Toll Brothers, which builds luxury homes in expensive suburbs, will build fewer homes in 2006 than it had planned. And existing homes are taking longer to sell. Still, real estate isn't in a crisis. Home prices have crested in parts of the Northeast and West, but values in those areas will deflate only a little and in an orderly fashion. Nationally, house prices will rise at their historical rate, 4% to 6%.

There will be a changing of the guard, but not of strategy, at the Federal Reserve. To keep inflation subdued, outgoing chairman Alan Greenspan and likely successor Ben Bernanke may oversee three more quarter-point rate hikes by early spring. Watch for ten-year Treasury-bond yields, now 4.6%, to reach 5.25% to 5.5%, the prime lending rate of banks (which affects home-equity lines and credit cards) to go to 8%, and 30-year fixed-rate mortgages, now 6.5%, to hit 7% to 7.5%. The Fed's challenge will be not to overdo the rate hikes and thereby stymie the economy.

But cheap credit won't return. "Bernanke won't want to appear soft," says Standard & Poor's economist David Wyss. "If inflation is kicking up, he may have a tendency to go too far." Let's just hope he can keep the economy off the ropes for another year.

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