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posted on 23 January 2015

December 2014 CFNAI Super Index Declines Due to Production Related Items

Written by Steven Hansen

The economy was growing slower based on the Chicago Fed National Activity Index (CFNAI) 3 month moving (3MA) average - but the economy remains well above the historical trend rate of growth.

The three month moving average of the Chicago Fed National Activity Index (CFNAI) which provides a summary quantitative value for all the economic data being released - declined from +0.54 (originally reported as +0.48 last month) to +0.39.

PLEASE NOTE:

  • This index IS NOT accurate in real time (see caveats below) - and it did miss the start of the 2007 recession.
  • The headlines talk about the single month index which is not used for economic forecasting. Economic predictions are based on the 3 month moving average. This index is very noisy and the 3 month moving average would be the way to view this index in any event.
  • This index is a rear view mirror of the economy.

A value of zero for the index would indicate that the national economy is expanding at its historical trend rate of growth, and that a level below -0.7 would be indicating a recession was likely underway. Econintersect uses the three month trend because the index is very noisy (volatile).

CFNAI Three Month Moving Average (blue line) with Historical Recession Line (red line)

As the 3 month index is the trend line, the trend is currently showing a decelerating rate of growth. As stated: this index only begins to show what is happening in the economy after many months of revision following the index's first release.

CFNAI Three Month Moving Average Showing Month-over-Month Change

The CFNAI is a weighted average of 85 indicators drawn from four broad categories of data: 1) production and income; 2) employment, unemployment, and hours; 3) personal consumption and housing; and 4) sales, orders, and inventories.

CFNAI Components - Production and Income (orange line), Employment / Unemployment & Hours (green line), Personal Consumption & Housing (blue line), and Sales / Orders & Inventory (red line)

Low Personal Consumption has been a headwind on the index for the last two years. The other three elements of the CFNAI have taken turns dragging the index down. The Chicago Fed's explanation of the movement this month:

Led by declines in production-related indicators, the Chicago Fed National Activity Index (CFNAI) fell to -0.05 in December from +0.92 in November. None of the four broad categories of indicators that make up the index increased from November, and two of the four categories made negative contributions to the index in December.

The index's three-month moving average, CFNAI-MA3, moved down to +0.39 in December from +0.54 in November. December's CFNAI-MA3 suggests that growth in national economic activity was above its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests modest inflationary pressure from economic activity over the coming year.

The CFNAI Diffusion Index, which is also a three-month moving average, decreased to +0.25 in December from +0.37 in November. Forty of the 85 individual indicators made positive contributions to the CFNAI in December, while 45 made negative contributions. Thirty-three indicators improved from November to December, while 52 indicators deteriorated. Of the indicators that improved, 14 made negative contributions.

Production-related indicators made a contribution of -0.12 to the CFNAI in December, down from +0.71 in November. Industrial production decreased 0.1 percent in December after moving up 1.3 percent in November, and manufacturing production increased 0.3 percent in December after a gain of 1.3 percent in November. However, manufacturing capacity utilization remained at 78.4 percent in December.

Employment-related indicators contributed +0.16 to the CFNAI in December, down somewhat from +0.21 in November. Nonfarm payrolls increased by 252,000 in December, down from a gain of 353,000 in the previous month. However, the unemployment rate decreased to 5.6 percent in December from 5.8 percent in November. The contribution of the sales, orders, and inventories category to the CFNAI remained at +0.03 in December. The contribution of the consumption and housing category to the CFNAI decreased to -0.12 in December from -0.03 in November. Housing permits decreased to 1,032,000 annualized units in December from 1,052,000 in November. However, housing starts increased to 1,089,000 annualized units in December from 1,043,000 in the previous month. The CFNAI was constructed using data available as of January 21, 2015. At that time, December data for 49 of the 85 indicators had been published.

The CFNAI explained:

With the significant amount of monthly backward revisions occurring, the three month moving average provides a better metric for economic activity levels.

Econintersect considers the CFNAI one of the best single metrics to gauge the real economic activity for the U.S. - and puts the entire month's economic releases into their proper perspective, although it is almost a month after the fact. It correlates well and historically has lead GDP - however its correlation post 2007 recession (New Normal) is uncertain. [graph below updated through May 2012 CFNAI]

As the CFNAI is a summary index, the data must be assumed correct to give it credibility. This assumption has been justified in the past because the index has proven to have a good correlation to the overall economy. When using this index, it is trend direction which is important - not necessarily the value when the index is above -0.7, the historical boundary between expansion and contraction.

Caveats on the Use of the Chicago Fed National Activity Index

The index is quite noisy, and the only way to view the data is to use the 3 month moving average. As this index is never set in concrete, each month a good portion (usually from January 2001 onwards) of the data is backwardly revised slightly. The most significant revision is in the data released in the last six months due to revisions of the 85 indices which are embodied into the CFNAI.

Even the 3 month moving average has over time significant backward revision. This is due both to changing methodology and backward revisions of this index's data sources. This point is important as the authors of this index have stated that -0.7 value is the separation between economic expansion and contraction. The graph below shows the difference between the original published index values and the values of the index as of August 2011.

This index seems to continuously creep - and when using this index in real time,Econintersect would assume the index values when first released could easily be off in a range +0.2 to -0.2 as the data in the future will be continuously revised. However, there are times when the uncertainty in real time can be much larger. For seven consecutive months in the Great Recession, backward revisions ranged from -0.7 to -0.9. In such times of severe economic stress the CFNAI has little real time accuracy, although it still definitely was showing that the economy was bad. It simply did not reflect exactly how bad in real time.

We can compare the CFNAI to ECRI's coincident index which is released monthly almost in real time. It is true that using ECRI's coincident index, the year-over-year rate of change is at recession levels - however, the CFNAI's rate of change provides a different conclusion.

In real time, ECRI's coincident indicator may be providing a better yardstick for the Wall Street economy. While in hindsight, CFNAI seems more intuitive - but is inaccurate in real time because of backward revision. GDP lives in its own world (as opposed to what economy is experienced by the population in their own lives) and has general correlation to most broad forecasts or coincident indexes as a selected view of the overall economy. However, I do not believe GDP has a good correlation to the Main Street economy.

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