Commentary Directory

The Chicago Fed Index Reverses in July

Jacob Hess
August 22, 2022

The Chicago Fed National Activity Index (CFNAI) pointed to some stabilization in economic indicators in July. The index had been in negative territory in May and June before reversing all the losses last month. In fact, the increase of 0.52 pts means that the index in July matched its value just 3 months ago at 0.27.

Two categories of indicators, the “sales, orders & inventories” and the “personal consumption & housing” indicators, were mostly neutral at just 0.01. The weakness in both of these categories reflects the weakening of demand, especially in the housing market, which has taken place as financial conditions and economic sentiment have weakened. However, there is still some support for personal consumption (in particular services consumption) as a result of excess savings and a strong jobs market.

The two stronger categories “employment, unemployment, and hours” and “production and income” point to the two strongest areas of the economy. The labor market is keeping the economy afloat with growth in wages and plenty of job openings. The decline in the unemployment rate in July was the reason why this component of the CFNAI shifted from negative to positive. Indicators tracking production reversed sharply in July on the strong 0.6% MoM industrial production print in July. The initial decline in demand is not having a strong effect on industry because firms are bouncing back from easing supply chain pressures.

Do Markets Have Ground to Stand on?

What does this mean for markets? The rebound in stocks over the past month or so seems to have some ground to stand on. SPY and QQQ are up 9.5% and 11.4% since June 15th, and many question the bullish sentiment pushing stocks higher after the declines in Q1 and Q2. These doubts are certainly valid as the May and June readings of the CFNAI made it clear that economic data is clearly moving to the downside, but investors have taken more positive data in stride. This includes a CPI report that was interpreted as a potential peak in US inflation.

Don’t get too excited because the worst is not behind us. Economic indicators can and very likely will reverse any strength seen in July. Some early reports like the Empire State Manufacturing Survey have shown a much weaker August. The Empire Survey’s General Business Conditions index plunged -42.4 pts to -31.3 this month with the New Orders index down -35.8 pts to -29.6. These are lows not seen since the pandemic. Financial conditions are just now starting to tighten to the degree that businesses will have to start adjusting to higher borrowing costs and, in general, tighter credit conditions.

Bears can also find the strength in July to be a point in their column instead of the bulls’. The Fed is closely monitoring economic data and shaping its tightening path meeting-by-meeting. Economic strength means that the FOMC can feel more comfortable about being aggressive in rate hikes and delaying rate cuts. In the same period that SPY and QQQ were up, the yield on the 2-year Treasury grew 3.75% to 332 basis points. Indeed, the 2-year yield bounced from being down -10% twice in the last 47 trading days suggesting investors sense hawkishness. That in itself is enough to justify the current rally breaking down.