Written by Steven Hansen
The May 2012 Chicago Fed National Activity Index (CFNAI) release shows the 3 month moving average degraded significantly into negative territory – indicating national economic activity was moderately below its historical trend. The index is clearly trending negative.
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 May – but that the expansion was significantly weaker than the previous month.
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).
This index is clearly degrading with the third month in a row of contraction, and is at the lowest level since June 2011
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:
Led by declines in production-related indicators, the Chicago Fed National Activity Index (CFNAI) decreased to –0.45 in May from +0.08 in April. Of the four broad categories of indicators that make up the index, three deteriorated from the previous month and two made negative contributions to the index in May.
The index’s three-month moving average, CFNAI-MA3, decreased from –0.13 in April to –0.34 in May—its third consecutive reading below zero and its lowest value since June 2011. 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 also moved lower in May, declining to –0.20 from +0.06 in the previous month. This marks the first time the CFNAI Diffusion Index was negative since June 2011. Thirty-two of the 85 individual indicators made positive contributions to the CFNAI in May, while 53 made negative contributions. Forty-seven indicators improved from April to May, while 36 indicators deteriorated and two were unchanged. Of the indicators that improved, nine made negative contributions.
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 – 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.