Written by Steven Hansen
The economy was less good in May 2013 – and this index is suggesting the economy is now expanding well below the historical trend rate of growth – with the Chicago Fed National Activity Index (CFNAI) 3 month moving (3MA) average decreasing from -0.04 (reported last month) to -0.43. The 3MA has now been in negative territory for three months, but still well above the levels associated with recessions.
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.
One more point, 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 which was less good. This index is very noisy and the 3 month moving average would be the way to view this index in any event. Note that the single month index is very noisy which is a secondary reason to keep your eyes on the 3 month moving average.
This index is a rear view mirror 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)
As the 3 month index is the trend line, the trend is currently “less good” or 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
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. The other three elements of the CFNAI have taken turns dragging the index down. This month all neutral or negative. The Chicago Fed’s explanation of the movement this month:
Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) increased to –0.30 in May from –0.52 in April. Two of the four broad categories of indicators that make up the index increased from April, but only one of the four categories made a positive contribution to the index in May.
The index’s three-month moving average, CFNAI-MA3, decreased to –0.43 in May from –0.13 in April, marking its third consecutive reading below zero and its lowest level since October 2012. May’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.
The CFNAI Diffusion Index decreased to –0.35 in May from –0.08 in April. Thirty-three of the 85 individual indicators made positive contributions to the CFNAI in May, while 52 made negative contributions. Forty-nine indicators improved from April to May, while 35 indicators deteriorated. Of the indicators that improved, 25 made negative contributions.
Production-related indicators contributed –0.10 to the CFNAI in May, up from –0.33 in April. The level of industrial production was unchanged in May after decreasing 0.4 percent in April. However, the Institute for Supply Management’s Manufacturing Purchasing Managers’ Index fell below 50 in May, decreasing to 49.0 from 50.7 in April.
Employment-related indicators contributed +0.01 to the CFNAI in May, up from –0.06 in April. The unemployment rate ticked up to 7.6 percent in May from 7.5 percent in April, but nonfarm payrolls rose by 175,000 in May after increasing by 149,000 in the previous month. The contribution from the consumption and housing category to the CFNAI in May was unchanged from the previous month at –0.17. Housing permits decreased to 974,000 annualized units in May from 1,005,000 in April, while housing starts increased to 914,000 annualized units in May from 856,000 in the previous month.
The contribution from the sales, orders, and inventories category to the CFNAI in May was also negative, moving down to –0.04 from +0.03 in April.
The CFNAI was constructed using data available as of June 20, 2013. At that time, May data for 51 of the 85 indicators had been published. For all missing data, estimates were used in constructing the index. The April monthly index was revised to –0.52 from an initial estimate of –0.53, and the March monthly index was revised to –0.48 from last month’s estimate of –0.23. Revisions to the monthly index can be attributed to two main factors: revisions in previously published data and differences between the estimates of previously unavailable data and subsequently published data. The revision to the April monthly index was due primarily to the former, while the revision to the March monthly index was due primarily to the latter.
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.