February 2012 CFNAI Down, But Index Up – Economy Still Good

Written by Steven Hansen

The February 2012 Chicago Fed National Activity Index (CFNAI) release shows the 3 month moving average of +0.30 —its highest level since May 2010 – indicating national economic activity was slightly above its historical trend.

The very noisy CFNAI (not the 3 month moving average) declined to –0.09 in February from +0.33.  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 index declined to –0.01 in February from +0.30 in January. Total industrial production was unchanged in February after rising 0.4 percent in January; and manufacturing production rose by 0.3 percent in February, following a much larger increase of 1.1 percent in the previous month.

Employment-related indicators contributed +0.18 to the index in February, down from +0.36 in January. Total payroll employment increased by 227,000 in February after rising by 284,000 in the previous month, and the unemployment rate was steady at 8.3 percent. In contrast, average weekly initial claims for unemployment insurance reached a four-year low in February.

The contribution from the consumption and housing category to the index was –0.27 in February, up slightly from –0.29 in January.  Housing permits increased to 717,000 annualized units in February from 682,000 in January, while housing starts edged down to698,000 annualized units from 706,000 over the same period.  The contribution from the sales, orders, and inventories category to the index also increased, ticking up to +0.01 in February from –0.03 in January.

Fifty-two of the 85 individual indicators made positive contributions to the index in February, while 33 made negative contributions.  Thirty-five indicators improved from January to February, while 49 indicators deteriorated and one was unchanged. Of the indicators that improved, 12 made negative contributions. The index was constructed using data available as of March 22, 2012. At that time, February data for 51 of the 85 indicators had been published.  For all missing data, estimates were used in constructing the index.

The January monthly index was revised to +0.33 from an initial estimate of +0.22. 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 January monthly index was due primarily to the former.

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.

Related Articles:

Econintersect Economic Forecasts

Past CFNAI posts