Surprises for 2006

2. Senate Judiciary Committee hearings on secret domestic wiretaps authorized by President Bush -- made without applying for a warrant from the court that handles sensitive national security issues -- find that the surveillance operation was far broader than admitted by the administration.

A special prosecutor begins an aggressive assault on the White House that results in Vice President Richard Cheney taking the fall for the administration and resigning by midyear. The president's popularity plunges as memories of Watergate are resurrected and the Democratic party takes a large lead in preliminary presidential polls. Condoleezza Rice is selected to replace Cheney as vice president.

3. The Federal Reserve, responding to the appearance of continued economic strength in fourth-quarter 2005 and in January 2006, continues to take the federal funds rate higher, just as the economy is about to sour. Bernanke pushes for and proceeds with a 50-basis-point increase in his first meeting as chairman of the Fed. (It turns out to be the last rate change over the balance of 2006.)

As the Fed and ECB continue tightening and the Bank of Japan ends its easing, bond yields initially rise early in 2006, but in the second half of the year, the 10-year U.S. note's yield dips to 3.65% as the market's focus moves toward potential rate cuts by the Fed and a potential recession in late 2006 or early 2007.

4. By early in the second quarter of 2006, the consumption binge of the last decade comes to an abrupt halt. Retail sales turn negative as the American consumer (the straw that has stirred the drink of the world economies) folds like a cheap suit and several former high-flying specialty retailers -- such as Abercrombie & Fitch(ANF Quote), Williams-Sonoma (WSM Quote), Urban Outfitters (URBN Quote) and so forth -- exhibit surprisingly poor same-store sales.

Weakness in personal consumption is exacerbated by many of the external shocks discussed in this piece: rising commodity prices, lower home prices (leading to weakening job creation and the lost ability to extract equity), stretched affordability of the first-time and repeat home buyer to purchase a new home, the absence of personal savings (and a safety net), rising debt-service requirements (proliferation and reset of floating-rate and interest-only loans), changes in credit-card payment requirements, etc.

5. There are a number of small-scale terrorist acts in the U.S. A failed attempt to contaminate a major region of the U.S.'s water supply sends already high agricultural product prices (in large measure reflecting South America's instability) to record levels, creating another inflationary scare.