Written by Steven Hansen
The March 2012 Chicago Fed National Activity Index (CFNAI) release shows the 3 month moving average of +0.05 — a decrease from February’s 0.30 — but still indicating national economic activity was slightly above its historical trend.
The very noisy CFNAI (not the 3 month moving average) declined to –0.29 in March from February’s downwardly revised -0.09. Please note this index value will be substantially changed in the coming months – as the underlying data releases will be revised.
The Chicago Fed National Activity Index (CFNAI) provides a summary quantitative value for all the economic data being released. The data is not spun or explained – it is what it is. However, this index IS not accurate in real time (see caveats below) – and it did miss the start of the 2007 recession.
A zero value for the index indicates 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).
Until December 2011, the index has remained in a tight negative range – it could be said the index has a flat trend – neither improving or degrading. Now the index is positive which is indicating normal economic growth.
This is a super coincident indicator – which by definition is a rear view economic picture.
The Chicago Fed’s explanation of the movement this month:
The contribution from production-related indicators to the CFNAI declined to –0.13 in March from +0.12 in February. Total industrial production was unchanged in both March and February, while manufacturing production edged down 0.2 percent in March after increasing 0.8 percent in February. Similarly, manufacturing capacity utilization decreased to 77.8 percent in March from 78.0 percent in the previous month.
Employment-related indicators contributed +0.09 to the CFNAI in March, down from +0.16 in February. Total payroll employment increased by 120,000 in March after rising by 240,000 in February. In contrast, the unemployment rate decreased from 8.3 percent in February to 8.2 percent in March, and average weekly initial claims for unemployment insurance reached a four-year low.
The contribution from the consumption and housing category to the CFNAI was –0.28 in March, down from –0.24 in February. Housing starts edged down to 654,000 annualized units in March from 694,000 in February, while housing permits increased to 747,000 annualized units from 715,000 over the same period. The contribution from the sales, orders, and inventories category to the CFNAI also decreased, ticking down to +0.03 in March from +0.04 in February.
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.
The CFNAI is significant because it 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. As mentioned previously, Econintersect uses the three month moving average for its analysis as the index is quite noisy – and the three month moving average smooths out the data so trends are more obvious.
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.
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 remarkable 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.