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And the New Year Will Bring ...

January 4, 2007 By:
Joel Naroff, JE Feature
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If you liked the ups and downs in 2006, you'll love 2007.

It was one of those years. Every time you thought you knew what was happening, conditions changed. Whether it was economic growth, energy prices, interest rates or even politics, the conventional wisdom turned out to be wrong -- at least for a while.

The actual strength of the economy was, and still is, the biggest puzzle. We started off as if 2006 was going to be a bang-up year. Robust first quarter growth was powered by massive spending by households and businesses.

But it all changed in the spring. Suddenly, uncertainty hit the corporate sector, and households, pummeled by ever-rising energy prices, slowed spending. The spring thaw was in growth.

At first, we thought the softening economy was only a temporary visitor. Unfortunately, with gasoline prices skyrocketing, we realized that it was our in-laws who had showed up and they had entrenched themselves in the guest room. The second half of 2006 was just as weak.

Three major problems created the slowdown. First, the housing bubble finally burst. Those who still believed in dot.coms thought housing wouldn't tank. Wrong again! Instead, home sales fell sharply, and developers, facing massive inventories, stopped building. Speculators discovered that the free lunch was now an expensive dinner bill. Consumers, who had used their homes as ATMs, stopped borrowing and slowed spending.

Feeling Sluggish?
The second problem was energy. Unimaginably high prices led us to directly deposit our paychecks into the oil companies' bank accounts. But autumn came and prices, like leaves, fell. They are still high and are still restraining growth, although not nearly as much as in the summer.

And then there's the domestic motor vehicle sector. Bleeding from losses, Detroit shed workers and cut production, causing national job growth to slow. Without major increases in payrolls, it is unclear how fast income and consumer demand can grow. However, even here the data were weird. Job gains went up and down, more than an old-fashioned roller coaster.

Amazingly, the nation's unemployment rate dropped to its lowest level in five years.

In the midst of all this, there was the Federal Reserve. Inflation kept rising and the Fed kept tightening, at least until June. Then, the members decided enough was enough. While short-term rates hit highs we hadn't seen since 2001, long-term rates did the two-step. They first rose, reflecting intensifying inflation. Then suddenly, they plummeted even as inflation accelerated.

But mortgage rates remained extremely low, preventing the housing market from totally collapsing.

We ended the year in a period of uncertainty. How slow will we go? Will the Fed cut rates? Can mortgage rates stay low or will they rise to reflect the real rate of inflation? These are all good questions.

So here is my fearless 2007 forecast: I expect the economy to remain sluggish through most of the year, but no recession appears to be in sight. The housing market and home prices still have a way to fall before the market stabilizes.

The Fed is likely to remain on hold until the summer and then start to cut rates. But remember, conditions do change so the path is likely to be as bumpy and uncertain in 2007 as it was in 2006. u

Joel L. Naroff, Ph.D., is chief economist for Commerce Bank.

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