Chicago Index Comes Out of the Stratosphere

The Chicago Fed regional activity index fell sharply from 61.7 to 52.9 in April. At 52.9 the index is below its median value of 54.7 since 1968. Orders are low by comparison with their historic median. Production is, however, quite solid, off modestly month to month and residing above its period median of 59. Employment improved month to month while backlogs slid and went below the breakeven value of 50 down to 48.4.

Why do we care? The main reason we care what the Chicago region prints is that it cycles closely with changes in the national ISM index. As we saw last month, not all Chicago readings are embraced nationally and, as you would expect, extreme regional movements are not harbingers of similar strength nationally. But the general trends of the Chicago index also sketch the trends of the national ISM-MFG. And what is important here is that the Chicago index is in an upswing phase. We do expect that to remain the case with national trends when the national index is released.

Even so, some odd things are afoot, not just nationally, with regionally erratic MFG readings, but also within some of these PMI surveys. To see Chicago’s strange reading this month we refer to the chart on the right.

It depicts a usually strong positive relationship between prices paid and supplier delivery lags. Slower delivery lags are a sign of capacity constraints beginning to bind and in such cases price pressures usually mount. When MFG is slack and delivery lags are shorter (weaker supplier index) prices tend to become slack as well. But what we see this month is a huge divergence that is getting worse. Prices paid are under further upward pressure. Meanwhile supplier delivery lags have sunk to diffusion reading of 43.4 which is in the bottom third of that variable’s historic range and in the bottom 17^th percentile of its full range of values since 1990.

Supplier deliveries tell us that there is plenty of slack and that deliveries are speeding up. Still we are seeing price pressures. Even the surge in the Chicago PMI last month did not do much to take up slack. Of course production is only above its own median historic reading for two months in row after being below it for five months running. So maybe this is just temporary. But it is a large divergence.

Summing Up. As expected, the Chicago PMI slowed down in April. But going back to the mid-1980s (you can also see this on the chart but its hard to gauge the magnitude) the Chicago PMI has averaged a stronger value than the ISM by about 3 points per month. That correlation would put the ISM just below 50 for April if it holds in the strict month-to-month sense. We don’t expect this. Since Chicago is coming off such a strong month a somewhat soured m/m comparison is not surprising. We do not take the Chicago PMI at face value for April. In March it was so strong, we do not even like moving averages for now. We think that the spike in March was an anomaly but we do think it was a signal and we expect the Chicago and the national ISM indexes to do better in the months ahead.