Correction to This Article
A Jan. 1 Business article on economic forecasts for 2006 incorrectly described changes in bond yields that resulted in an "inverted yield curve." In the last week of December, the yield on two-year Treasury bonds rose above that of 10-year bonds, not the other way around.

Out on the Horizon

By Neil Irwin
Washington Post Staff Writer
Sunday, January 1, 2006

A year ago, the overwhelming consensus of economic analysts was that the U.S. economy would grow strongly in 2005.

But if you had told those forecasters about some of the challenges the nation would face in the past year -- the destruction of a major city, gasoline prices that for a time hit $3 a gallon, a slowing in the housing market late in the year -- you likely would have persuaded them to predict a year of weaker growth.

You would have persuaded them wrong. The consensus turned out to be exactly right, as the nation's total output looks to have grown by about 3.7 percent over the course of the year, despite the headwinds.

There's a lesson in that as forecasters try to figure out what the economy will do in 2006. One can never be sure what will fill the business pages next year (a big hedge fund collapse? a General Motors bankruptcy?). What one can do is try to understand the underlying trends in the economy, the big, slow-moving forces that shape the nation's collective financial prospects. Think of the U.S. economy as a tanker ship, constantly buffeted by waves and wind -- this oil price spike, that currency devaluation -- but changing direction only gradually and when bigger economic forces are at work.

So what underlying path is the economy on for 2006? Forecasters generally believe it is going to grow at a healthy pace, though slightly slower than in 2005. Economists at Lehman Brothers Holdings Inc., the investment firm, expect sufficiently smooth sailing that they illustrated their 2006 forecast with a photo of a sailboat moving across placid waters. Their outlook reflects the consensus view.

The Bond Market Association surveyed economists at 29 member firms, mostly big investment companies. They expect gross domestic product, which measures the value of all goods and services produced in the United States, to grow 3.4 percent next year -- reasonably strong by historical standards, but down three-tenths of a percentage point from 2005.

That doesn't mean the economic outlook is all sunshine and sailboats. Economists see a slumping housing market to be the biggest risk for the economy in 2006, as interest rates rise and housing supply rises to meet -- and, increasingly, exceed -- demand. Just last week, the National Association of Realtors said that the number of homes on the market rose to its highest level in more than a year. The consensus of the economists surveyed was that the number of existing homes sold will drop 6 percent to 6.7 million, and that the number of houses builders start building and the number of new-home sales will also fall.

"Clearly the slowdown in housing will mean slower growth in the overall economy," said Nigel Gault, an economist at consulting firm Global Insight Inc. "The big question mark is how much damage there will be."

The answer may depend on just how much the steady growth in recent years has depended on housing. It would appear to be a lot. Economists at Wells Fargo & Co. analyzed job growth since 2001 and found that half of the nation's new jobs have been in fields tied to housing -- real estate agents, mortgage brokers, construction workers and the like. And booming housing prices appear to be a major factor in the rapid climb of Americans' spending in recent years, which many economists argue has been enabled by cash-out refinancings, home equity loans and a sense that they need not save because their homes made them worth so much on paper.

With all those factors in play, Moody's Inc., an economic consultancy, estimates the booming housing market added 1 percentage point to economic growth in 2005.

"Unfortunately," writes Lehman Brothers economist Ethan Harris in a report, "the housing boom and the spending it fuels is unsustainable."

If the slower housing market has a worse impact on the overall economy than mainstream economists forecast, it could even spell the end of the four-year economic expansion. Mark Zandi, chief economist at, figures the probability of a recession in 2006 is 10 percent, given the strong momentum in the economy. But he raises the likelihood to 20 percent for 2007.

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