Written by Steven Hansen
The economy weakened in October 2012 with the Chicago Fed National Activity Index (CFNAI) 3 month moving (3MA) average falling to the lowest level since October 2009. The 3MA has remained in negative territory for the last 8 months – indicating national economic activity was below its historical trend, but now only slightly above the levels associated with recessions.
The index’s trend remains “less good” (positive growth, negative acceleration) – meaning the economy is softening. The Chicago Fed National Activity Index (CFNAI) provides a summary quantitative value for all the economic data being released. However, this index IS NOT accurate in real time (see caveats below) – and it did miss the start of the 2007 recession.
This index is a rear view mirror of the economy, and whilst the tend is clearly negative – the index is telling that the economy did expand in October – but that the expansion was very much under the potential of the economy.
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).
CFNAI Three Month Moving Average (blue line) with Historical Recession Line (red line)
The index had been on a deteriorating trend line for 2012.
CFNAI Three Month Moving Average Showing Month-over-Month Change
This is a super coincident indicator – which by definition is a rear looking view of the economy.
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 & 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 year. Over the last 5 months, the other three elements of the CFNAI have taken turns dragging the index down. This month all except employment and business sales were negative. The Chicago Fed’s explanation of the movement this month:
Thirty-one of the 85 individual indicators made positive contributions to the CFNAI in October, while 54 made negative contributions. Thirty-three indicators improved from September to October, while 51 indicators deteriorated and one was unchanged. Of the indicators that improved, 13 made negative contributions.
Production-related indicators contributed –0.45 to the CFNAI in October, down from –0.06 in September. Hurricane Sandy negatively affected industrial production in October. Manufacturing production decreased 0.9 percent in October after increasing 0.1 percent in September, and manufacturing capacity utilization declined to 75.9 percent in October from 76.7 percent in the previous month.
Employment-related indicators contributed +0.07 to the CFNAI in October, down from +0.13 in September. The unemployment rate ticked up to 7.9 percent in October from 7.8 percent in September; but nonfarm payrolls increased 171,000 in October, compared with 148,000 in September. The contribution from the sales, orders, and inventories category to the CFNAI also decreased in October, moving down to +0.01 from +0.10 in September.
The contribution from the consumption and housing category to the CFNAI decreased to –0.19 in October from –0.17 in September. Housing starts increased from 863,000 annualized units in September to 894,000 in October—their highest level since July 2008. However, housing permits declined from 890,000 annualized units in September to 866,000 in October.
The CFNAI was constructed using data available as of November 21, 2012. At that time, October data for 51 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.