To Say Chicago Fed National Index Up is Disingenuous

The headline for the Chicago Fed’s National Activity Index (CFNAI) stated that economic activity picked up in October 2010. Econintersect considers the CFNAI and employment data to be one of the most important economic indicators released each month.  The headline:

Led by improvements in production- and employment-related indicators, the Chicago Fed National Activity Index increased to –0.28 in October from –0.52 in September. Three of the four broad categories of indicators that make up the index made small positive contributions in October, while the consumption and housing category continued to make a large negative contribution.

The index’s three-month moving average, CFNAI-MA3, decreased to –0.46 in October from –0.33 in September, reaching its lowest level since November 2009. October’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend for the fifth consecutive month. With regard to inflation, the amount of economic slack reflected in the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

Production-related indicators made a contribution of +0.08 to the index in October, up from –0.12 in September. Manufacturing industrial production increased 0.5 percent in October, up from a 0.1 percent gain in the previous month; and manufacturing capacity utilization increased to 72.7 percent in October from 72.3 percent in September.

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.  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 obvious.

Econintersect considers the CFNAI a single metric to gauge the real economic activity for the economy – and puts the entire month’s economic releases into their proper perspective.

It therefore is a little disingenuous for the headlines to talk about index improvement when the three month moving average (MA3) fell. The 3 month moving average is used to calculate recession and inflation potentials – inflation potential decreased, recession potential increased.  Still, the MA3 remains above the -0.70 line where the Chicago Fed has determined there is a likelihood a recession has began.

The data in this index has been backward revised through June 2009 in this release.  The overall revision is considered by Econintersect as minor.

As the CFNAI is a summary index, the data must be assumed correct – and it has a remarkable correlation to the economy.  When using this index, it is trend direction which is important – not necessarily the value when the index is above -0.7.  The CFNAI MA3 trend is telling us the economy is continuing to soften.

The analysis of the Chicago Fed relating to the effects of the various groupings to the changes in this month’s CFNAI:

Employment-related indicators made a contribution of +0.03 to the index in October, up from –0.06 in September. Total nonfarm payroll employment increased by 151,000 in October, and private nonfarm payrolls rose by 159,000. In addition, the Institute for Supply Management’s Manufacturing Employment Index moved up to 57.7 in October from 56.5 in September.

The sales, orders, and inventories category contributed +0.05 to the index in October, down from +0.08 in September. The Institute for Supply Management’s Manufacturing New Orders Index increased sharply in October, rising to 58.9 from 51.1 in September.

The consumption and housing category contributed –0.43 to the index in October, down marginally from –0.41 in September. Housing starts declined to 519,000 annualized units in October from 588,000 in September, while building permits edged up to 550,000 annualized units in October from 547,000 in the previous month.

Forty-one of the 85 individual indicators made positive contributions to the index in October, while 44 made negative contributions.  Forty-five indicators improved from September to October, while 39 indicators deteriorated and one was unchanged. Of the indicators that improved, 20 made negative contributions.

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