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Risky Business in '06? Could Be

The bond market's signal of slower economic growth ahead sent shivers through financial markets this week and raised questions about the strength of the current expansion.

That sign came when long-term interest rates fell below short-term rates in the Treasury bond market on Tuesday and Wednesday -- a so-called inverted yield curve that has traditionally meant slower growth, or even recession, ahead.

The economy grew at a solid 4.1 percent annual rate in the third quarter, after expanding 3.8 percent in the first quarter and 3.3 percent in the second quarter. Full-year growth of about 3.7 percent seems to be in reach.

But while there is disagreement about the outlook for 2006, many economists were already forecasting a slowdown, with growth of about 2.5 to 3.3 percent or so, even before the signal from the Treasury market.

"We have a pretty good idea (that growth will slow) for the first half and maybe through the summer," said Anirvan Banerji, director of research at the Economic Cycle Research Institute. "Beyond that, we ought to be honest and admit that it gets fuzzy."

Here's a look at a number of factors to watch to see if the economy stumbles or stays strong in 2006.

Shocks to the system

The United States proved surprisingly hearty this year, as record $70 a barrel oil, higher interest rates and the most expensive hurricane season in history all failed to spoil the party.

What kind of shocks will 2006 hold? No one knows for sure. But Banerji says there's more reason to worry about the jolts ahead than the ones from this year.

"A lot of people have assumed the economy has become so structurally resilient it won't be a problem if there are more shocks in 2006," he said. "But the resilience is not likely to be as high in 2006, especially in second half of the year.

"The difference has to do with where we are in business cycle," he said. "Things are likely to get more wobbly, and that makes the economy more vulnerable. Pretty much any shock could be a problem."...

Manufacturing rebound

Right now manufacturing is poised to grow at a faster pace than the service sector in 2006, said Banerji of the Economic Cycle Research Institute.

"It's not very usual for that to happen, but contrary to popular perceptions, not everything moves in synch," he said.

Manufacturing, despite being battered in recent decades, is still an important source of good paying jobs and wealth creation, accounting for about 11 percent of U.S. jobs overall.

And even if the housing market slows, some economist say federal assistance and insurance proceeds for rebuilding the Gulf Coast, along with increases in highway and infrastructure recently approved by Congress, will keep construction employment strong.