Written by Jeff Thredgold, President, Thredgold Economic Associates
Economic Consultant to Zions Bank

The American Economy
…solid growth continues
Quarterly U.S. economic growth has been at a 3.0% or higher real (after inflation) annual rate during each of the past 10 quarters, something not seen in 20 years. Estimates for 2006 suggest real growth of 3.0% to 3.5%, versus near 3.7% in 2005 and 4.2% in 2004. The economy's ability to offset the headwinds of rising short-term interest rates and high energy prices has been impressive.

The Federal Budget
…greater challenges later
Solid U.S. economic growth and sharply higher tax receipts reduced the budget deficit for fiscal year (FY) 2005, which ended last September 30, to $318 billion, a major improvement versus 2004's $412 billion shortfall. A deficit close to that of FY2005 is likely in FY2006. Budget challenges get more daunting in coming years.

Employment
…tighter and tighter
The nation's unemployment rate, averaging 5.0% in recent months, peaked in June 2003 at 6.3%, a nine-year high. Joblessness averaged 5.5% in 2004 and 6.0% in 2003. Additional slight reductions should occur over the next 18 months. Net job creation has been solid (if quite volatile) during the past 24 months, with the addition of more than 4.1 million net new jobs. A similar pace is likely in '06.

Inflation
…the Katrina effect
Consumer prices rose 3.4%-3.8% in 2005, tied to painful natural gas prices and higher building material costs. By comparison, consumer prices rose 3.3% in 2004. Good news? Most forecasts have consumer prices rising around 2.5% in 2006.

Intense global competition, price-sensitive consumers, more effective use of technology, and the competitive nature of the Internet will help keep inflation in check. We expect additional moderation in energy costs in the new year.

The Federal Reserve
…13, 14, 15
The Federal Reserve has consistently withdrawn excess monetary stimulus during the past 18 months. A total of 13 tightening moves (0.25% each) now find the critical "federal funds rate" at 4.25%, as compared to a 46-year low of 1.00% between June 2003 and June 2004.

The Fed's next Open Market Committee meeting is January 31, with Ben Bernanke assuming the Big Chair from Alan Greenspan. Financial markets expect a 14th move at that meeting, with the chance of up to two more moves before summer.

Long-Term Interest Rates
…still remarkably low
Mortgage rates could move slightly higher over the next 6-12 months, tied to volatile energy prices and concerns about less foreign purchases of U.S. Treasury securities. Even so, rates will remain attractive.

Mortgage interest rates have been at or near 40-year lows during the past four years. The result?…the strongest new home sales and existing home sales on record.

Home Prices
…slowing in 2006?
Greed-driven surges in home prices, especially on both coasts and in the Southwest, set the stage for possible weakness in 2006. A stock market analogy seems appropriate…"Bulls and Bears can make money…Pigs get slaughtered." We expect greater home price strength in the nation's interior…less strength on both coasts.

The Global Economy
…modest slowing likely
Overview: Most forecasts see slightly weaker global economic growth during 2006, following impressive growth in 2004 and 2005. Recent performance has been the strongest since the late 1970s. As before, risks to this view include any major new terrorist atrocities (especially on American soil) and a worsening of Middle East tensions.

Any discussion of the Pacific Rim must begin with Japan, a nation that still accounts for more than half of all Asian economic output and still ranks as the world's second largest economy. Japan returned to modest economic growth during the past 12-15 months…following "the lost decade" of economic stagnation. Rising exports to China and stronger consumer spending have helped Japan.

Chinese leaders are seeing some success in slowing the economy down. China's appetite for all types of commodities, including oil, steel, copper, and cement, which had been almost insatiable, has finally slowed a bit.

India's economy continues to perform well, with rising success in developing world class performance. Most other economies in the Pacific Rim are performing reasonably well.

The European economy continues to disappoint. Kingpins Germany and France struggle with miniscule growth and jobless rates near 12.0% and 10.0%, respectively.

"Old Europe" faces mounting pressures to constrain future government spending for current and impending retirees…spending they simply cannot afford. U.K. performance has weakened.

The Russian economy is growing, a beneficiary of high oil prices and rising oil production. Economic decline in Africa ranks as the global community's major failure of the past 50 years.

The South American economy has slowed somewhat, led by weaker growth in Brazil. Various Latin American nations are benefiting from capital now returning for investment, a sign of rising confidence.

Canadian economic growth has been modest, with unemployment at 6.4%, a 30-year low. The Mexican economy is growing at a reasonable clip, with the immigration issue raising emotions both in the U.S. and south of the border.

The Bottom Line?
U.S. economic growth during the past 30 months has been impressive, with plenty of government stimulus in play. Solid growth is likely to continue. In addition, we expect: another 12-digit budget imbalance…solid employment gains…declining inflation pressures…steadily increasing short-term interest rates, with slightly higher long-term rates…softer coastal housing markets…and an anxious but impressive global marketplace.

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