There are many variables that can influence bank interest rates, but knowledge of key economic indicators can provide indications of the future direction of interest rates. Watching and evaluating economic indicators will help ascertain the position of the U.S. economy and determine the forces that are shaping the future direction of bank interest rates. Some of the most common economic indicators referred to by the Federal Reserve include the following:
Real Gross Domestic Product (GDP)
Real Gross Domestic Product is provided by US Department of Commerce; Bureau of Economic Analysis. The GDP report is published quarterly and revised monthly. The data is typically released during the final week of the month. The first or advance estimate is released during the final week of the month immediately following the end of a calendar quarter. The preliminary estimate is published in the second month, followed by the revised estimate in the third month.
Real Gross Domestic Product is defined as the total value of goods and services produced within the borders of the United States. The growth of output is measured in real terms; meaning increases in output due to inflation have been removed. There are five main components of the GDP are: consumption, fixed investment, change in inventories, government purchases and net exports. GDP is considered the most comprehensive measure of economic activity for all the sectors of the U.S. economy.
By monitoring trends in the overall growth rate, the Fed is able to assess whether the current stance of monetary policy is consistent with their primary goal of stable economic growth. Unexpectedly high quarterly GDP growth is perceived to be potentially inflationary if the economy is operating near full capacity. This, in turn, causes interest-bearing investments to drop in value and yields and interest rates to rise. A strong report GDP report raises the concern that the Fed might tighten monetary policy and raise the Fed Funds rate to avoid higher inflation. The general economic view is that growth rates that are above a natural growth rate cannot be sustained for too long and will ultimately lead to strained resources and can cause inflation. Conversely, a contraction, or economic downturn may cause the Fed to intervene and lower interest rates to stimulate the economy and increase the growth rate.
Consumer Price Index (CPI)
The Consumer Price Index (CPI) is provided by the U.S. Department of Labor; Bureau of Labor Statistics. The CPI is prepared Monthly. The data is typical made available the second week of the month immediately following the month for which data is being released.
The rate of change of the CPI is one of the key measures of inflation for the U.S. economy. The Consumer Price Index is defined as an index designed to measure the average change in price paid by consumers for a fixed market basket of goods and services. The relative weight of each category in the CPI is approximately grouped as follows: housing 42%, food 18%, transportation 17%, medical care 6%, apparel 6%, entertainment 4%, other 7%. The index is intended to measure pure price change only. The Bureau of Labor Statistics makes some attempt to remove changes in price resulting from changes in quality of goods measured in the index.
Large quarterly increase in the Consumer Price Index price is, by the definition of the index, inflationary. An increasing or decreasing trend in monthly CPI figures may signal that the Fed might change its stance on monetary policy. High CPI inflation is bad news for most interest rate paying accounts. Strong inflation report causes concern the Fed might need to intervene and raise interest rates. Likewise, a lower-than-expected figure is bullish for the market, causing the bond to gain and yields to fall.
Payroll Employment
The Nonfarm Payroll Employment report is provided by U.S. Department of Labor; Bureau of Labor Statistics. The employment repost is a monthly composition. The data is released monthly on the first Friday of the month for the immediately preceding month; occasionally it is released on the second Friday.
The Nonfarm Payroll Employment report is an estimate of the number of payroll jobs at all nonfarm business establishments and government agencies. Information is also provided on the average number of hours worked per week and average hourly and weekly earnings. The data provided is used to refine GDP estimates. The employment report is one of the most widely followed monthly reports.
Payroll jobs move with the economy and help define business cycles. The nonfarm payroll employment series is one of the key economic statistics that the National Bureau of Economic Research analyzes to determine whether the economy is expanding or contracting. Job growth can be a key to understanding consumer sentiment as well. Consumers feel more at ease when the job market is expanding and more cautious when employment opportunities contract. While the payroll data is extremely important and can be a significant market mover, it is subject to sizeable revisions.
The government’s employment report is the most significant monthly economic indicator reported. While the GDP report is more important, it is published only quarterly rather than monthly as the employment report. Its importance derives from the fact that it provides a signal early each month about the employment conditions in he previous month and provides important information about the current and likely future pace of overall economic growth. Over time, these data have proven to be an important indicator of economic conditions because they move closely in line with the overall economy. Monthly payroll jobs data by industry also are published on a timely basis for state and metropolitan areas, so economists can evaluate economic conditions for those regions and make comparisons with other geographic areas. this industrial detail helps the Fed to evaluate labor market and business conditions across a wide array of industries.
Larger than expected growth of employment and hours worked or a lower than expected unemployment rate is considered inflationary, causing interest rates to rise. The bond market and interest rate sensitive assets views a weak report favorably, conversely, a strong figure cause yields and interest rates to rise. The report also makes it more likely that the Fed will increase the Fed Funds rate that is also bearish for the bond market.
The movement in average hourly earnings provides information about supply and demand conditions in labor markets. These numbers give an indication on the potential resource utilization in the economy as well as indication of inflation if wages continue a trend higher. Jobs and income are, of course, a significant measure of the performance of the U.S. economy.
Industrial Production and Capacity Utilization
The Board of Governors of the Federal Reserve System compiles industrial Production and Capacity Utilization. Both indices are released monthly, the preliminary estimate released around the middle of the month for the immediately preceding month. Theses indices are expressed as a percentage of production in a base year. Currently, the base year is 1987. The data is typically expressed as an increase or decrease from the prior month.
The Industrial Production and Capacity Utilization indices are designed to measure changes in the level of output in the industrial sector of the economy. The industrial production index measures the physical volume of output of the nation’s manufacturing sector, including factories, mines, and utilities. The index is grouped by products; consumer goods, business equipment, intermediate goods, and materials as well as by industry; manufacturing, mining, and utilities. Capacity utilization measures the extent to which the nation’s capital is being used in the production of goods.
The level of capacity utilization in the industrial sector offers information on the wide-ranging level of resource utilization in the economy that may in turn provide information on the likely future course of inflation. The utilization rate rises and falls with business cycles. As production increases, capacity utilization rises. Its application is sometimes expanded to analyze potential changes in manufacturing employment, average hourly earnings and income. The data is closely watched for signs of inflation pressures when utilization runs close to capacity.
Retail Sales
Retail Sales is an estimate prepared by U.S. Department of Commerce, Bureau of the Census. The data is released monthly where there is an advance estimate released during the second week of the month for the immediately preceding month.
Retail sales data is an estimate of the total sales of goods by all retail establishments in the U.S. The data is presented in nominal dollars, meaning they are not adjusted for inflation. Durable goods, such as autos and appliances, make up 35% of the figure. Personal consumption expenditures, which roughly measure all consumers spending, represent roughly two-thirds of GDP. Sales of services are not included in the retail sales report.
By monitoring retail sales, Federal Reserve policy makers are able to make an assessment of the likely growth of PCE for the current and future quarters. Large increases in sales may lead to a larger increase in consumer spending and consequently lead investors to believe the Fed may have to raise rates to slow economic growth.
Business Sales and Inventories
Business Sales and Inventories are produced by the U.S. Department of Commerce; Bureau of the Census. The numbers are produced monthly about six weeks from the end of the month.
The significance of this report is the combined data it provides. The total business sales are numbers that are released separately but this report combines all the data of retailers, manufacturers and wholesalers. The numbers released on inventories is the primary source of data on inventories or the amount of goods that manufacturers, wholesalers and retailers keeping their stockrooms. And finally the Department of Commerce calculates the inventory to sales ratio.
Understanding the rate of inventory accumulation plays a key role in determining the current pace of economic growth and often provides useful clues about the future pace of growth as well. For example, if inventories are accumulating at a rapid pace, such that inventory sales ratios are rising, it may portend a slowing of growth in the near future as firms cut production to bring inventories back into line with sales. Vice versa, if inventories are growing slowly or actually falling, it may signal a future pickup in production. The inventory to sales ratio provides an easy to view statistic on the changes in the position of these components.
Durable Goods
Advance Durable Goods Shipments, New Orders and Unfilled Orders provided by the U.S. Department of Commerce; Bureau of the Census. Produced monthly released the fourth week of the month for the immediately preceding month.
Advance durable goods shipments, new orders and unfilled orders is a bundle of information on shipments, new orders, and unfilled orders, expressed in current dollars, for things such as primary metals, fabricated metals, electric generating equipment, non electrical machinery, information processing equipment, and transportation equipment, including civilian and military aircraft and ships, light-, medium-, and heavy-duty trucks, and automobiles.
Durable goods are considered those products that have a expected to last more than three years. The data in the report provides a view on the strength of demand for manufactured durable goods. An increase in orders, shipments, and unfilled orders suggest demand is strengthening. The increased demand may lead to expanding economy that is either expanding beyond a long-term sustainable level or that demand for credit to handle the orders is heating up. When there is a trend of larger than expected monthly increases, the outcome with is likely to result in rises in interest rates. Falling orders, shipments, and unfilled orders suggest the opposite. Data in this release also provides information on the current and likely future pace of business investment in new equipment.
Durables good orders have been extremely volatile and is frequently revised following its release. Economists typically extract the defense and transportation orders from the aggregate figures. These components can be the most volatile aspects of the combined number.
Having the capacity to interpret economic forces and the ensuing interest rate cycles can be extremely valuable in preparing investment strategies.
Interest rates are strongly affected by the prevailing economic forces of the market. For the past several decades, general levels of interest rate have been highly correlated with the overall U.S. business cycle. The key factors that are influenced the most by economic cycles are the supply and demand for credit and the rate of change in purchasing power. Most all factors regarding the economic cycle have a significant impact on interest rates and inflation. Banking and credit exhibit some of the greatest pressures and changes from the expansion and contraction of during business cycles. Observing the movement in business cycles has a distinct value to all investors especially those in interest rate sensitive assets.
Wages and prices will begin to rise at faster rates if monetary policy stimulates aggregate demand enough to push labor and capital markets beyond their long-run capacities. In fact, a monetary policy that persistently attempts to keep short-term real rates low will lead eventually to higher inflation and higher nominal interest rates, with no permanent increases in the growth of output or decreases in unemployment. As noted earlier, in the long run, output and employment cannot be set by monetary policy. In other words, while there is a trade-off between higher inflation and lower unemployment in the short run, the trade-off disappears in the long run.
The Federal Reserve policy makers look at the broadest monthly indicator available as well as the trend line of the indicators. The largest barometer of economic activity, gross domestic product, is actually given relatively little weight because it is only measured quarterly and it is subject to continuing, large revisions.
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