The Chicago Federal Reserve National Activity Index and Steel Supply

Written by Peter Wright

The following is the Chicago Federal Reserve statement followed by our own graphical analysis. The CFNAI is an excellent reality check for much of the economic analysis that we routinely provide in The Steel Market Update and is also a reasonably good predictor of the direction of steel demand with a six to nine month lead. For example by the time the steel market went off the cliff in September 2008, the CFNAI had been signaling an increasingly severe problem for eight months. Then in the first Q of 2009 the CFNAI was recovering as steel supply was still going south. An explanation of the Index is provided at the end of this piece.

The official statement reads as follows:

Index shows economic growth picked up in January

Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) rose to +0.28 in January from –0.34 in December. Two of the four broad categories of indicators that make up the index increased from December, and two of the four categories made positive contributions to the index in January.

The index’s three-month moving average, CFNAI-MA3, increased to –0.15 in January from –0.30 in December. January’s CFNAI-MA3 suggests that growth in national economic activity was somewhat 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, which is also a three-month moving average, ticked up to –0.11 in January from –0.17 in December. Thirty-nine of the 85 individual indicators made positive contributions to the CFNAI in January, while 46 made negative contributions. Forty-five indi­cators improved from December to January, while 39 indicators deteriorated and one was unchanged. Of the indicators that improved, 14 made negative contributions.

The contribution from production-related indicators to the CFNAI increased to +0.27 in January from –0.38 in December. Industrial production increased by 0.9 percent in January after declining by 0.7 percent in December. Moreover, manufacturing production in­creased by 0.5 percent in January after decreasing by 0.2 percent in the previous month. The sales, orders, and inventories category made a contribution of –0.03 to the CFNAI in January, up slightly from –0.04 in December.

The contribution from employment-related indicators to the CFNAI moved down to +0.12 in January from +0.16 in December. Nonfarm payrolls increased by 151,000 in January after increasing by 262,000 in December. However, the unemployment rate ticked down to 4.9 percent in January from 5.0 percent in the previous month.

The contribution of the personal consumption and housing cate­gory to the CFNAI was unchanged at –0.08 in January. Housing starts decreased somewhat—to 1,099,000 annualized units in January from 1,143,000 in December. Housing permits also moved down a little—to 1,202,000 annualized units in January from 1,204,000 in the previous month.

The CFNAI was constructed using data available as of February 18, 2016. At that time, January data for 51 of the 85 indicators had been published. For all missing data, estimates were used in con­structing the index. The December monthly index value was revised to –0.34 from an initial estimate of –0.22. Revisions to the monthly index value 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 December monthly index value was due primarily to the former.

SMU Analysis

The CFNAI declined for three straight months through November, declined at a slightly slower rate in December then did an abrupt reversal in January when it improved from negative 0.34 in December to positive 0.28 in January (see explanation below). The January improvement was insufficient to put the 3MMA into the black and this measure had a value of negative 0.15 in January, an improvement from negative 0.30 in December. Figure 1 shows the SMU analysis of the three month moving average (3MMA) through January.

Figure 2 shows the trends of the four main subcomponents.

There was a gradual five year improvement in personal consumption and housing through mid-2015 but since then this component has lost direction. The other three sub-components continue to be erratic. There was a strong downward trend in employment and hours worked that picked back up in November through January. There was a marked drop in production and income in the fourth quarter of 2015 which improved in January. If our observations here seem to be at odds with the official statement it is because we discuss only three month moving averages.

Figure 3 compares the 3MMA of steel supply based on AISI data + imports with the CFNAI and shows that the index has historically been a reasonably accurate leading indicator changes in direction of steel demand (apparent supply) with a lead time of six to nine months.

SMU monitors several benchmark indicators to evaluate whether steel consumption is where it should be based on historical patterns, this is one of them. We believe that this comparison is more valid for direction than it is for absolute value and that the peaks of steel demand were very clearly led by this index. If the relationship holds and the CFNAI continues to improve we can expect an increase in steel demand in the third quarter of 2016. Figure 4 and Figure 5 show this same relationship for flat rolled and long products separately, based on a rolling three months tonnage for each.

The difference is quite dramatic and qualitatively in agreement with our analysis of steel service center shipments. Note; steel supply shown is only through December as that is the latest data available.

Explanation: The index is a weighted average of 85 indicators of national economic activity 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. A zero value for the index indicates that the national economy is expanding at its historical trend rate of growth; negative values indicate below-average growth; and positive values indicate above-average growth. When the CFNAI-MA3 (three month moving average) value moves below –0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun. Conversely, when the CFNAI-MA3 value moves above –0.70 following a period of economic contraction, there is an increasing likelihood that a recession has ended. When the CFNAI-MA3 value moves above /+0.70 more than two years into an economic expansion, there is an increasing likelihood that a period of sustained increasing inflation has begun.

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