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Forget Goldilocks, U.S. economy feels more like Jekyll and Hyde

WASHINGTON—For much of last year, Wall Street analysts referred to America as having a Goldilocks economy, one that wasn't too hot or too cold. Now into its fourth year of expansion, the U.S. economy might better be described as Dr. Jekyll and Mr. Hyde.

In any given week, conflicting economic reports emerge that seem to either prove or disprove that inflation threatens, that interest rates must rise or fall or that the nation's hot housing market is safely cooling or on the verge of collapse.

These conflicting indicators make it hard for analysts to project the economic future. And if they can't see the way forward, what's a consumer to do?

For example, given the uncertain future path of interest rates, should a consumer buy a home now before lending rates rise further or wait a few months in hopes that they'll fall?

Should a consumer act on the hope that gasoline prices will fall and snap up a discounted sedan or SUV being offered by a full-inventory carmaker, or should she buy a more fuel-efficient vehicle on fears that gasoline prices will climb higher?

There are no easy answers. Part of what's fueling the conflicting indicators is that the economy is well into its current expansion, which makes it hard to tell if the country is in the middle or toward the end of the growth.

All expansions eventually end. Even the longest peacetime expansion, which began in March 1991, ran out of steam in March 2001. Few experts think this expansion will last that long, but few see recession just around the corner either.

Instead, they see a confusing maze of conflicting indicators.

"In the expansion phase of the business cycle, which is after recovery from recession, you're always in this range of trying to determine whether the economy is overheating or not," said John Taylor, a Stanford University economics professor who was a U.S. Treasury Department undersecretary until late last year.

Today's U.S. economy is bolstered by a strong global one with a much sounder financial foundation than was present during the 1990s. Back then, Russia, Asia and Latin America were rocked by currency crises. No such threats are visible now, and the Bush administration projects U.S. growth this year to be between 3.1 percent and 3.3 percent.

Still, dueling indicators suggest that the U.S. economy has a split personality worthy of the Jekyll-and-Hyde character in the classic Robert Louis Stevenson tale.

On Monday, oil prices climbed to record nominal highs of more than $72 a barrel. That stoked fears of inflation and weaker consumer confidence, so Wall Street slumped.

Then on Tuesday, Wall Street rallied because producer inflation data were tame and minutes from the Federal Reserve's latest rate-setting meeting suggested that it might raise short-term interest rates only one more time. "One-and-done" Wall Street cheered; investors thought that after the Fed notched a 16th consecutive quarter-point hike, to 5 percent, on May 10, it would end a credit-tightening cycle that began in June 2004.

That would put the brakes on mortgage rate increases, which have risen from the 2004 average of 5.84 percent on a 30-year fixed-rate mortgage to a national average of 6.53 percent Thursday. That's the highest mortgage rate since July 12, 2002.

But the "one and done" consensus appears short-lived.

On Wednesday, the Labor Department released consumer price data that showed that core inflation—which excludes volatile energy and food prices—rose by 0.3 percent. That's the fastest growth rate since March 2005.

The Fed minutes from Tuesday had showed that officials believed core inflation was flat or dropping. That no longer seemed true.

The Fed's primary mission is to fight inflation, so the core data "raises the likelihood that it's going to be two hikes and not one," said Kenneth Beauchemin, chief U.S. economist for Global Insight in Boston.

Another quarter-point rate hike at the Fed's June 28-29 meeting would push short-term rates to 5.25 percent, influencing bank loan rates for consumers and businesses.

That would complicate the housing outlook further.

The hot housing market and cheap lending rates helped fuel much of the current economic expansion. National Realtors Association data show median home prices grew 53.2 percent between 2000 and 2005. Many economists think that steep rise reflected a speculative bubble fit to burst in the hottest markets on both coasts.

Just about every indicator now suggests a slowing housing market, especially in California and Florida. New housing starts nationwide fell 7.8 percent in March, and prices appear flat for existing homes, which are also lingering longer on the market.

"The anticipated degree of decline in starts for 2006 (6 percent to 7 percent) still qualifies as a `soft landing' for the housing market, following unsustainable exuberance in 2005," David Seiders, chief economist for the National Association of Home Builders, wrote in his April 19 column. "We expect much of the decline to reflect withdrawal of investors/speculators from housing markets" as double-digit gains in home prices become less likely.

But if mortgage rates rise above, say, 7 percent, to 1999 levels, experts fear it could cause housing prices to fall, which could pull down consumer spending and the U.S. economy.

Yet if the Fed dares not push rates too high lest it burst the housing bubble, it also dares not leave rates too low, lest they encourage the ongoing buying bubble for commodities. Prices for oil, copper, platinum, gold and other metals are soaring, partly from financial speculation.

"Housing gets weaker with higher (interest) rates, but if they're holding off tightening because they don't want to let housing get too weak, it opens the possibility for inflating the commodity bubble," warned Ed Yardeni, a chief investment strategist for global investor Oak Associates in Akron, Ohio.

Some of the commodities surge is due to demand for natural resources spurred by the strong global economy, but that has also attracted financial speculators, who are bidding up prices.

The commodities-research division of London-based Barclay's Capital believes that institutional funds invested about $80 billion into contracts for oil and other commodities in 2005, and the figure is likely to exceed $100 billion this year.

The companies that need the raw materials are responding in kind.

"The actual end users, the businesses that actually need these commodities, are discovering that they are making more money by accumulating inventory than turning it into products," Yardeni said. "It's sort of creating a panic-buying situation, scrambling to hoard."

Round and round the economy goes, where it spins next, nobody knows.

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(c) 2006, Knight Ridder/Tribune Information Services.

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