Forecast for 2005: Mostly clear skies
By Sue Kirchhoff and Barbara Hagenbaugh, USA TODAY
WASHINGTON — For better — and for worse — this year's economy is expected to look a lot like 2004.
Inflation is expected to be below worrisome levels. Housing and consumer spending should remain firm, and the Federal Reserve will likely continue raising interest rates in baby steps. But those hoping for a return to the 1990s pattern of frenzied job creation and frenetic business spending are likely to be disappointed yet again.
While the job market should steadily improve, the wage gap between lower-skilled workers and their better-educated peers could grow. U.S. exports will accelerate, but possibly not enough to cut the yawning trade deficit, given weak growth abroad.
"We are well-positioned for fairly healthy economic conditions (over the) next year," Federal Reserve Bank of Richmond President Jeffrey Lacker said in a speech last week.
While most economists see the recovery as self-sustaining, they also see risks. The outlook for energy prices is uncertain, while high debt levels make some of them question the strength of consumer spending. Record budget and trade deficits threaten foreign investment in the USA. Corporate profits are expected to ease from their previously rapid pace. Terrorism is a wild card.
Many economists, including those at Merrill Lynch and Global Insight, predict slightly slower growth in 2005 than the strong 4% rate of last year. Few expect the economy to actually accelerate.
"The truth is, despite all the market angst at the start of 2005, the economy appears to be in the comfortable middle," says David Kelly of Putnam Investments.
EMPLOYMENT
More jobs, little change in unemployment rate
U.S. businesses are expected to create 175,000 to 225,000 net jobs a month, perhaps rising from the 186,000 average seen in 2004. Job growth will be driven by a stable economy and a possible slowing in productivity growth, which lets companies produce more with fewer workers.
Rob Weinberg, who runs San Diego marketing and consulting firm The MarketBuilding Team, is preparing to hire staff in response to stronger-than-expected business.
"The elections came and went, and everyone breathed a huge sigh of relief," Weinberg says. "I'm hearing from people about contracts that have been on hold for months."
Still, the unemployment rate is expected to decline only slightly from the 5.4% registered in December, or even rise, as people re-enter the job market. Despite the creation of 2.2 million jobs in 2004, employment is still below 2001 levels. Factories, which lost about 3.3 million workers since 1998, should hire 10,000 a month in 2005.
Economists caution that higher employment might not translate into higher pay, especially for millions of hourly employees whose earnings did not keep pace with inflation during much of 2004. Better-educated, skilled workers should fare better.
"We will be adding jobs, but many of the gains will continue to be concentrated at the higher end," says Jared Bernstein of the non-profit Economic Policy Institute.
Economy.com expects business to create good-paying jobs in the professional, technical and health care services, among others. Construction employment is expected to slow, along with mining and other commodity production. Average hourly earnings adjusted for inflation should rise 1.3%, the consulting firm says.
SurePayroll, which performs payroll services for firms across the country, says small-business employment grew 4.4% in 2004, based on a survey of about 140,000 companies. But average paychecks dropped 4.8%. SurePayroll President Michael Alter expects pay to decline in 2005, just not as much.
"We have manufacturing firms in Wisconsin. We pay their workers $14 an hour. If they hire a new worker, everyone knows the new worker will take $10, but they're happy to take the job," Alter says.
ENERGY
Oil prices could fall as supplies continue to rise
The oil markets started the year much as it ended 2004: on a seesaw — down one day, up the next. Expect more of the oil market roller-coaster ride in 2005, most energy analysts say.
"We're going to still see volatility in the oil market," says Mark Baxter, director of the Maguire Energy Institute at Southern Methodist University.
Concerns about availability of oil supplies, which led the market to record highs in 2004, have eased somewhat, particularly as unseasonably warm weather has reduced demand for heating oil this winter. And gasoline inventories are far ahead of where they were this time last year.
Sizable increases in supplies, coupled with consumers' desire to conserve energy in light of recent price increases, will lead to declining prices in 2005, particularly in the first half, says IFR Markets senior energy analyst Tim Evans. He says oil prices could be in the low $30s at some point this year.
But Wachovia economist Jason Schenker expects the average oil price will be $46 a barrel this year, up from $41 in 2004. He argues that continued growth in economies around the globe will increase demand.
INFLATION/INTEREST RATES
Competition should keep prices stable as rates rise
Prices are expected to creep higher this year as continued economic growth gives businesses latitude to raise prices.
But strong competition from businesses at home and abroad will prevent companies from raising prices too much.
And some economists, including those on The Bond Market Association's advisory committee, expect inflation to slow a bit this year, in part in response to expected lower energy costs.
Richard Yamarone, director of economic research at Argus Research, says he expects the inflation rate to rise slightly in 2005, but, "The inflation genie is not out of the bottle." He notes that while prices in some sectors continue to rise, other costs, including for personal computers and energy, are falling.
"It's not so problematic that it's going to cause economic growth to crumble," Yamarone says.
Low inflation will give the Federal Reserve room to continue to raise interest rates at a slow, steady pace, preventing a jarring rise in rates that could dramatically slow the economy. The Fed last year raised its target for short-term interest rates five times to 2.25% in a bid to bring rates to a more "neutral" level, where rates neither stimulate nor slow the economy.
This year, economists expect the Fed's target will end the year around 3.5%, a level close to the neutral level.
HOUSING
Demand will keep higher rates from stifling sales
New and existing home sales are expected to dip slightly below 2004's record level. Home prices should rise about 5% to 6% on average, down from the double-digit gains of 2004. Still, economists caution that since the mid-1990s they've regularly, and wrongly, predicted the historically strong housing market will cool.
Housing analysts expect rates on 30-year, fixed mortgages, now about 5.8%, to remain under 7% through 2005 — with some expecting rates below 6.5%. Even if rates rise faster, the market should remain solid because demand outstrips supply in many areas.
"If you look at this real estate boom we've been through, we've had years where interest rates have gone up, but housing continued to expand in a very healthy way," National Association of Realtors chief economist David Lereah says.
Tracey Boy Bethune, manager of the Winston-Salem, N.C., office of Allen Tate Realtors, expects another good year in 2005. The firm, the largest independent realtor in the Carolinas, is preparing for higher interest rates by discussing alternative financing plans with buyers. But it doesn't expect higher rates to take much of a bite out of business.
"Transactions will be on the rise. This region, and the growth that we see with the overall economic outlook, is positive," Bethune says.
"As far as the average price, we will venture to say that it will trend up as we see more full-amenity communities and more executive-level opportunities open up."
Some economists warn housing prices have reached unsustainable levels, rising nearly 50% on average in the past five years. Federal Reserve members see signs low interest rates are breeding some market speculation. But a recent study by the staff of the Federal Reserve Bank of New York discounted the idea that a national housing bubble could pop.
DOLLAR
More declines on horizon, but free fall not expected
The dollar could decrease in value for the fourth consecutive year in 2005 but is unlikely to go into a dangerous tumble as the U.S. economy remains the most attractive place to invest.
The dollar has fallen 25% in value in relation to a basket of major foreign currencies in the last three years, according to the Federal Reserve. The decline has been larger against some other currencies and is hovering near an all-time low against the euro.
Continued concerns about near-record U.S. trade and budget deficits and their potential effect on the U.S. economy will likely lead to more declines in the dollar this year, some economists, including Global Insight chief economist Nariman Behravesh, say.
But Behravesh says a number of factors will keep the dollar from going into a free fall. The European and Japanese economies are showing signs of faltering, making the USA still one of the most attractive places for foreign investors to park their money.
"The U.S. is still the only major engine of growth," he says. "It's in no one's interest for something nasty to happen to the U.S."
William Hummer, chief economist at Wayne Hummer Investments in Chicago, expects the dollar will actually strengthen against the euro, in part because of the comparative strength of the U.S. economy. The expectation that the Fed will continue to raise interest rates will also lure investors who are seeking the greatest return on their money, he notes.
CONSUMER SPENDING
Mood good for shopping
Consumers are expected to continue to spend in 2005, as extended job growth, lowered energy prices, the end of election uncertainty and rising stock and housing values put them in a shopping mood. Consumers' expectations to buy cars, homes and major appliances and to take vacations in the next six months all rose in December, according to the Conference Board.
Teddi Culp, co-owner of SportsTown, which operates four sports apparel stores in northern Ohio, says she noticed a big difference in consumers' moods after the presidential election, when an extreme amount of caution was replaced by a sense of relief. Holiday spending was up in 2004 from a year ago, despite lackluster outcomes from some area sports teams.
Consumers "seem to be out having fun and are seeing the light at the end of the tunnel," she says.
Economists keep a close eye on consumer spending because it accounts for more than two-thirds of U.S. economic activity.
Not everyone is convinced consumers can keep up their spending. Consumer spending has been boosted in recent years by low interest rates, tax cuts, mortgage cash-outs and a surge in home prices, Merrill Lynch says. Others have questioned whether high debt levels and rising interest rates will force consumers to shut their wallets.
"The reality is that after a huge buying spree in the past few years, there is nothing that the households really need," Merrill Lynch economists wrote in a recent research note.
MANUFACTURING/TRADE
Software sector may slow, but exporters in luck
U.S. factories were walloped by the 2001 recession. Last year, the sector began to revive: Profits and production rose; orders for computer software soared and orders for construction machinery surged more than 30%.
Manufacturers Alliance chief economist Daniel Meckstroth says the software sector could slow, while autos and construction equipment production will be down. The weaker dollar should help exporters by making U.S. products cheaper abroad.
Ilia Lekach, CEO of Parlux Fragrances of Fort Lauderdale, expects his hot-selling Paris Hilton perfume, deals with Guess clothing maker and tennis stars Maria Sharapova and Andy Roddick, and the weaker dollar to help him in emerging markets such as Eastern Europe.
"In general, I'm very optimistic about this year," Lekach says. "The euro (has been) very strong, so America can export a lot."
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