Deciphering Economic Reports
Paying close attention to the daily stream of economic reports is the best way to stay one step ahead of the Federal Reserve. And staying one step ahead of the Fed can be very profitable.
Most investors analyze any fresh economic data by trying to figure out if the news makes the Fed more or less likely to change monetary policy.
The Fed's main preoccupation for the past 20 years has been containing inflation.
The Fed endorses the view that inflation accelerates when unemployment falls so low that firms are forced to pay more to recruit and retain quality workers. Firms then pass along the higher wages by charging more for their output. Inflation then spirals through the economy, the theory goes.
The Phillips Curve
This theory is known by various names, including the reserve army of the unemployed, the Phillips Curve, the "natural rate" of unemployment and the odd-sounding acronym NAIRU, which stands for "nonaccelerating inflation rate of unemployment."
The Fed looks at most economic indicators through the inflation lens. Any indication that the supply of available labor or any other vital input is shrinking or that demand for that input is rising can be argument for higher interest rates at the Fed.
Fed Chairman Alan Greenspan is known to carefully watch commodity prices and deliveries for any signs of shortages or bottlenecks that could lead to overall higher prices.
The usefulness of any economic data can be ranked by three criteria: Relevance, timeliness and accuracy.
Monthly jobs report
By all three measures, the monthly jobs report is the most significant economic indicator. It is among the first data released about any given month, it looks at the most important sector of the economy, it is conceptually sound and is based on surveys of thousands of businesses and households.
The Labor Department also gives a more detailed look at total compensation costs in the quarterly employment cost index, which includes wages and benefits.
Other indicators also give snapshots on the labor market. Every week, the Labor Department reports on unemployment claims. Private sources, like the monthly survey of the manufacturing sector by the National Association of Purchasing Management, the Conference Board's Help Wanted Index and the Challenger report on mass layoffs, help paint a complete picture of the labor market.
Looking At Demand
To look at the demand for labor and other scarce inputs, economists look at dozens of reports, generally divided by sector.
Demand from consumers, who account for about 70 percent of final sales, is indicated by the Commerce Department's monthly income and spending report and from monthly or weekly reports on wholesale and retail activity from the Commerce Department, retailers, retail analysts and automakers, and from consumer confidence surveys published by the University of Michigan and the Conference Board. The Fed tself keeps track of consumer debt, a key constraint on consumer spending.
Investment in the housing and construction market, which is extremely sensitive to economic conditions, can be gleaned from the Commerce Department's housing starts, construction spending and new home sales reports and from private data from the National Association of Realtors and the National Association of Homebuilders.
Investments not tracked
Oddly, the investments businesses make in new equipment, techniques and skills are not tracked with any sophistication by the government or private source. The best source of information about investment comes in the quarterly gross domestic product report.
Inventories, on the other hand, are tracked in several Commerce Department reports. Inventory levels can help predict future levels of output and employment.
Demand in the manufacturing sector, which also tends to rise and fall with the business cycle, can be seen in the Commerce Department's reports on orders for durable goods and factory orders, as well as the Fed's own report on industrial production and capacity utilization. The NAPM survey is closely watched because it offers a quick backward view at the previous month as well as an expectations index for future demand.
The international component is increasingly important to the U.S. economy. The Commerce Department reports on international trade with a significant time lag, but in considerable detail, at least for goods. The Labor Department reports monthly on import and export prices in a variety of sectors and with most of the nation's major trading partners.
The government sector is becoming less important over time as fiscal policy contracts. The Treasury Department's monthly budget statement contains valuable information on government purchases, transfer payments and especially the amount of taxes Washington has received.
Gross domestic product
Putting it all together, the Commerce Department releases the first of its three estimates of the gross domestic product about a month after each quarter's end.
The GDP report includes several inflation gauges, including the implicit price deflator.
Each month, the Labor Department releases the better-known Consumer Price Index for goods and services at the consumer level and the Producer Price Index for prices of goods received by factories, farms and mines. The CPI and PPI are timely and thorough, but they have been criticized for overstating inflation. They do not give an advance look at inflation to come.
To better understand inflation, the Fed looks at the quarterly productivity numbers from the Labor Department. While productivity is conceptually the most important economic indicator of long-term economic growth, difficulties in measuring productivity limit the usefulness of this report.
Many economic reports suffer from various inaccuracies. The government reports on the GDP for eac quarter three times, revising its estimates as better data become available.
Besides being a helpful way of keeping up with the Fed and the macroeconomy, government and private data can also help investors find healthy sectors to favor or unhealthy sectors to ignore.
By Rex Nutting