Editor's note: The following review is based on the most recently available information as of March 17, 2006.

The domestic economy enjoyed a relatively tranquil first quarter, devoid of any serious disruptions. The most notable events were fluctuations in the price of crude oil and the retirement of Federal Reserve Chairman Alan Greenspan, with the succession to that post of Ben Bernanke.

As expected, the Fed raised short-term interest rates to 4.50% in January. Bernanke, in his first address to Congress as Fed Chairman, reiterated Greenspan's homilies on containing inflation. Thus, the Fed is expected to raise rates to 4.75% at its March 28 meeting, with speculation centering on possible increases beyond that.

Fed officials have indicated that their comfort range for inflation lies in the 1% to 2% range (on an annualized basis), whereas annual rates have teetered between 1.9% and 2.3% for about the last 18 months. The Fed's expressed concern is that volatile energy prices will lead to price increases in other areas.

Bubbling crude
The price of crude oil experienced volatility during the quarter, but investors remained largely unflappable. Prices rose almost 4% to $63.42 per barrel over the first two trading days of the year, and climbed to $68.35 on January 20 as the world focused on Iran's nuclear desires and the possible ramifications, such as a reduction of oil supplies from Iran. But the situation was left to simmer and prices fell to $57.65 per barrel less than a month later. Unrest in Nigeria, another oil-rich region, led to supply disruptions, which saw prices rise above $62 in early March.

The situations in Iran and Nigeria will be closely monitored by investors, whose actions will be felt in other markets. The Dow Jones Industrial Average fell over 200 points on January 20, its largest one-day percentage decline since 2003, in reaction to rising oil prices. Gold futures reached a 25-year high, hitting $572.50 on February 2, although this price dropped to $539 less than two weeks later. Gold is often a refuge for investors looking to ride out storms in other markets and commodities.

The Labor Department announced that the unemployment rate fell to 4.7% in January, its lowest point since July 2001, although it suffered an uptick to 4.8% in February. Coincidentally, initial claims for unemployment fell in February to a six-year low. Consumers continued to infuse the economy with money, as retail sales were strong in January, due to gift card redemptions and warm weather throughout the country.

Consumer confidence, which rose last fall and early this winter, declined in February, according to The Conference Board's Consumer Confidence Index, a representative monthly sample of 5,000 U.S. households. This Index, which accounts for both respondents' present situations and their future expectations, revealed that while consumers feel good about the current economic climate, they are concerned about how matters will play out in the coming months. Perhaps these respondents have been reading reports of a slowdown in sales of existing houses and increasing inventories of houses for sale (as reported by the National Association of Realtors). Many Americans have tapped their homes' equity to finance their spending and any diminution in the value of their homes could bleed into the larger economy. Americans in 2005 spent more money than they earned in income for the first time since the Great Depression, a phenomenon made possible by the strong housing market. According to the Economic Policy Institute, inflation-adjusted hourly and weekly wages remain below the point they were at when the economic recovery began in November 2001.

Stocks in the black so far
The stock market took steps toward a strong 2006. Despite the one-day decline in the Dow on January 20, that benchmark and others scaled heights not seen since 2001. But large-cap stocks remained in a narrow trading range so far during the first quarter with investors waiting to see what course is charted on interest rates and oil prices. Small-cap stocks were especially strong in the first quarter to date, continuing a trend that has prevailed for several years now. Mid caps also outperformed large caps thus far during the first quarter. At press time, all sectors are in positive territory, led by telecom, which has seen a flurry of mergers and acquisitions activity.

Prices on 10-year Treasury bonds fell, pushing yields to their highest levels in almost two years. This was due to speculation that inflation might prod the Fed to continue to increase rates through the spring and into the summer. The yield curve briefly inverted, a situation in which yields on short-term bonds are higher than those on long-term bonds. Precedents of this nature have foreshadowed past recessions, but Bernanke, in comments to Congress, said that a recession does not appear to be brewing by his reckoning.

The dollar weakened against the euro in the first two trading days of 2006. The drop of 2.5% was the largest such decline in five years. The dollar bottomed out on January 25, with $1.22 required to obtain one euro. At press time, this exchange had improved to $1.20 per euro.

FIRST QUARTER INDEX COMPARISONS

Source: The Wall Street Journal

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