The Economic Forecast: U.S. and Pittsburgh to Expand

For 2006, the U.S. economy’s prospects remain favorable, along with those of Asia, North America and, to a lesser extent, Europe. One key assumption underlying our sanguine global economic outlook is that crude oil prices will fluctuate within a $45 to $70 per barrel range, but average close to $55 per barrel in 2006, down slightly from $58 per barrel in 2005.

U.S. real GDP in 2006 is expected to advance at a moderate 3.1 to 3.5 percent pace, only slightly slower than the 3.6 percent real GDP growth rate estimated for 2005. This will reflect the desirable combination of continued solid worker productivity growth of 2.0 to 2.5 percent and payroll job growth of 1.3 to 1.6 percent. The latter translates into a rise of 1.7 to 2.2 million payroll jobs and a modest decline in the unemployment rate to near 4.8 percent by December 2006.

PNC Advisors (PNC’s wealth management division) projects that the S&P 500 stock index will end 2006 in the range of 1,350 to 1,400, up 5 to 7 percent from year-end 2005. This should mirror the rise we expect in S&P 500 company earnings per share this year. As energy prices stabilize in 2006, consumer price inflation (CPI) should be slower than the estimated 3.5 percent rise in 2005. In contrast, the core CPI (excluding food and energy) will advance at a slightly faster pace of 2-1/4 to 2-1/2 percent in 2006. This will keep the Federal Reserve, led by its new chairman Ben Bernanke, on guard against the risk of a more intense pass through of inflationary pressures.

A smooth transition

The odds favor another 25-basis point funds rate hike at both of the FOMC’s meetings on Jan. 31, 2006 (Greenspan’s last meeting) and March 28, 2006 (Bernanke’s first meeting as chairman), bringing the Fed funds rate to a “neutral” 4.75 percent, and the bank prime rate to 7.75 percent before the FOMC takes a well-deserved rest. By this spring, the 10-year Treasury note and 30-year fixed mortgage rates should climb to near 4.75 percent and 6.75 percent, respectively. At that time, the Treasury yield curve will be virtually flat with three-month to 10-year Treasury interest rates all close to 4.75 percent.

The further rise in mortgage interest rates and tighter lending conditions during the year ahead will reduce home building and buying from record levels in 2005. A growing inventory of unsold homes will limit the national average rise in home prices to near 5 percent in 2006, less than half of the frenzied home price surge in 2004 and 2005. This will temper consumer spending, but consumers will remain an important source of economic growth in 2006, as their jobs and incomes rise.

Improving prospects for Pittsburgh

The Pittsburgh Metropolitan Area economy began moving in the right direction in 2005, but has much ground to regain. Total employment in the metro area rose by just 0.2 percent in 2005 (preliminary estimate), or just over 2,000 jobs. These job gains, however, were largely confined to trade, business services and health care. With the exceptions of health care, education and financial services, employment in every major industry group remains below the job level seen prior to the 2001 recession. Manufacturing and transportation have suffered the steepest job losses. Pittsburgh’s unemployment rate drifted lower last year and should remain near 5 percent in 2006. (See forecast table for more details.)

Pittsburgh’s economic fortunes will continue to improve in 2006 as employment growth is forecasted to be 1 percent, equaling 10,000 new jobs. One encouraging sign for the metro area economy is the recent growth in employment related to corporate headquarters. Though well short of levels seen at the height of Pittsburgh’s heyday as a center for corporate activity, recent growth in headquarters jobs could be a precursor of a pickup in the broader economy. Health care and business services will provide key support, while manufacturing should stabilize. Longer term, Pittsburgh’s efforts to attract high-tech and biotech industries will help boost its growth prospects. Continued weak demographic trends, however, will act as a drag on economic growth.

Despite what has been only a modest recovery in the job market, metro area personal income growth is strengthening. Growth in wages and salaries reflects the metro area’s significant cluster of jobs in areas such as business and professional services and health care that have been adding jobs over the past two years. As the metro area economy solidifies through 2006 and job growth picks up, growth in earnings will become broader-based and support continued growth in total personal income.

Fueled by low mortgage rates, housing has been a source of critical support for the Pittsburgh region economy, with high levels of home building and sales in recent years. Despite the strength of sales, the 5 to 6 percent pace of house price appreciation in the metro area during the past two years lagged considerably behind the 12 percent national average. The slower pace of house price appreciation is due, at least in part, to the metro area’s weak rates of population growth and household formation, which have limited growth in housing demand. While the pace of home building and home sales will slow in 2006, both building permits and sales will remain at fairly high levels as the area housing market cools. There is certainly no local housing price bubble that will burst from higher mortgage rates.