What's next, as the surprises keep on coming

Surprises, they come to economists not singly, but in battalions.

Just when many analysts were cranking out reports of a peak in oil production, and a permanent new era of $80 or $100 oil, crude oil prices fell by about 25%.

The multiple surprises that produced this drop include:

A Saudi plan to increase production capacity by 1.5m barrels per day even though at present it can't sell all the oil it produces; oNew, unanticipated discoveries in the Gulf of Mexico and in non-Opec countries, adding several million barrels per day to world supplies; oA drop in demand for oil as the US economy slows; oA fall in the risk premium as it has become clear that the UN Security Council prefers a nuclear-armed Iran to sanctions.

But just as those surprises were absorbed in forecasts, along came another: the Opec oil cartel quietly passed the word to its members that output reductions are not a bad idea if prices are to be maintained at a level it could only dream of a few years ago, but to which it has now grown accustomed. Result: an uptick in oil prices.

More surprises are undoubtedly in store, as the Saudi royal family tries to decide whether it should shore up crude prices by cutting back production, but in the process surrendering hundreds of millions of dollars in revenues that it needs to fund the kingdom's social programmes.

America's housing market also continues to surprise. Sales of new homes are down by 17% from a year ago, and sales of existing homes by 12%.

With inventories of unsold homes at a 13-year high and rising, it is no surprise that prices are finally dropping.

But just as most analysts decided that the market had gone from cool to frigid, with dire consequences for the overall economy, the August figures provided another surprise. Sales of new homes rose by 4.1%.

One data point does not make a trend, so it would be foolish to say that the bottom has been reached in a market in which prices are still estimated to be 25% above levels that can be sustained by current incomes.

However, the recovery in sales, which sparked a bit of a recovery in shares of home builders, is a reminder that there is more at work in this market than is immediately apparent. For one thing, mortgage rates are falling and real incomes are rising, giving a bit of strength to demand.

And consumer confidence provided another surprise: it took a significant leap in September, as consumers' views of the job market and their earnings outlook grew cheerier, and a 60 cents-a-gallon drop in petrol price added $78billion (£ 41.79billion) to Americans' purchasing power, according to economists at Morgan Stanley.

The biggest surprise of all has been the stock market, which at the time of writing this has been flirting with record highs after rising almost 10% on the year.

With the housing market in decline, and labour costs rising at a rate of about 5% as compensation gains (about 8%) outstrip productivity improvements (about 2.5%-3%), the bears were prepared to rampage down Wall Street. In the event, they have been gored by the bulls.

Explanations for this surprise vary. Some say that the continued strength of profits (up 20% in the second quarter over last year) and cashflow have resulted in a general undervaluation of shares, a view held by 35% of money managers surveyed by the Russell Investment Group, which manages over $170 billion in assets.

Other bulls think that the slowing economy makes it certain that the Federal Reserve Board's monetary policy committee will either end the ratcheting-up of interest rates, or soon begin to lower them. Still others expect the dollar to drop like a stone, providing new opportunities for export industries, for made-in-the-USA goods, and for leisure and entertainment industries as more and more Americans fill their tanks with cheaper petrol, and tour the US rather than fly off to Europe.

The dollar, of course, remains another source of surprises. It is weakening, but it has not collapsed, and even jumped higher on news of rising consumer confidence, despite International Monetary Fund fears of "a disorderly dollar adjustment", and despite accumulating downward pressures.

Treasury secretary Hank Paulson was unable to persuade his many friends in the Chinese government to allow a significant appreciation in the renminbi. No surprise there.

But the Chinese did surprise by passing the word that they have stored just about as many pictures of US presidents in their bank vaults as they deem prudent, suggesting that they will diversify their reserves away from dollars.

Meanwhile, all signs point to an increase in interest rates in euroland while US rates remain unchanged or fall. That will undoubtedly make it relatively more attractive to hold euro- denominated assets, while further weakening the greenback.

Finally, we have the surprise of continued growth. The economy has slowed but not stalled. Edward Lazaer, chairman of the president's Council of Economic Advisors, told a Senate committee last week he expected growth to slow in the remainder of this year, but to proceed "at a robust pace in 2007 and beyond". He also reported that "weakness in the housing sector does not seem to be spreading to other sectors of the economy".

This article originally appeared in the October 1 edition of the Sunday Times. (London)