Kamp's Comments - 2006: What Might It Hold?

by Leo Kamp, Managing Director and Chief Investment Economist, TIAA-CREF

Don't expect this year to be a replay of 2005 -- when economic conditions were good -- not as buoyant as in the previous year, but good nonetheless. The economy is likely to be markedly different in 2006.

• Overall economic growth will likely slow, perhaps significantly. While the first half of the year should show growth that's close to trend (about 3% real GDP growth annualized), look for a significant deceleration in the second half of the year. Importantly, we anticipate slower real consumer spending growth (driven in part by declining automobile purchases) and decreases in housing activity.
• Oil prices will likely peak in the first quarter of 2006 and tick down on average for the remainder of the year.
• With the economy on a slower path, we expect hardly any tightening of the labor markets next year.
• With energy prices lower, the economy slower, and energy-price-induced inflation pressures abating, the Fed will likely stop tightening sometime in the first half of 2006 - although not until after the Treasury yield curve has become slightly inverted.

By the end of the year, then, we will likely have less to rejoice over, at least with respect to economic growth. Even so, the economy, while slower, most probably will not fall into recession.

Moreover, major long-term challenges, namely twin trade and budget deficits, will still be with us in 2006. With mid-term elections later this year, look for little action from Congress, particularly in the House, to resolve these critical issues. Certainly, we should expect no tax increases and few spending cuts from Congress in an election year - absent, of course, a significant financial crisis.

In addition, there are likely to be few, if any, initiatives from Congress to improve private-sector saving. Any such actions would likely involve scrapping, or substantially reducing, long-cherished household spending incentives (e.g., the tax deductibility of mortgage interest, including that on home equity loans) - moves that are not politically feasible in an election year.

The expected lack of Congressional action to help rectify our budget and trade imbalances this year simply postpones the day when these deficits must be resolved, most likely with more pain and greater cost than if they were dealt with now. These problems don't diminish with time; they increase.  So while consumer confidence may be looking up for now, it will be difficult to sustain that level of optimism when the chickens of inaction finally come home to roost.