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Timothy Slaper
Indiana Business Research Center

George Vlahakis
University Communications

Last modified: Thursday, March 18, 2010

Leading Index for Indiana sagged in February

March 18, 2010

BLOOMINGTON, Ind. -- After a year of a slow progress, the Leading Index for Indiana retreated in February.

This news follows what had been a discouraging report for January, when the index gained no ground.

LII Feb. 2010

"The LII's movement seems to reflect the fact that economic good news, like the greater than expected increase in retail sales in February, has been mixed with economic bad news, like the drop in consumer sentiment. These two economic news items were even reported on the same day," said Timothy Slaper, director of economic analysis at the Indiana Business Research Center at IU's Kelley School of Business.

Slaper also noted that trends are not set by one month's activities. The Center for Econometric Model and Research (CEMR) at IU has forecasted a U-shaped economy recovery for the state with sustained economic and employment growth taking root in the middle of the year.

"Even with this slight slip in the LII, one can still be relatively optimistic about the economic and employment growth forecasted for the middle to the end of the year," he said.

Drivers of Change

The NAHB/Wells Fargo Housing Market Index (HMI) weighed down the Indiana index. Builder confidence in the market for newly built, single-family homes fell back two points to 15. The HMI lost all the ground it had gained in January as distressed property sales posed increasing challenges to both builders and buyers. Each of the HMI's component indexes fell. Some attribute the situation to lack of available credit for new projects, the large number of distressed properties for sale and the hesitancy of potential buyers because of the weak job market.

There was one bright spot on the home building front. The inventory of new homes on the market is at an extremely low level, and the NAHB expects a 25 percent improvement in new-home construction in 2010 over 2009 to rebuild inventory and meet expected pent-up demand. Regionally, the HMI results were mixed. While the Northeast posted a five-point gain, the Midwest HMI slid three points to 10.

In contrast, the Dow Jones Transportation Average, after dipping about 5 percent in January, gained back January's lost territory and then some. The DJTA rose about 6 percent.

Economic activity in the manufacturing sector expanded in February, but at a slower rate. The Purchasing Manager Index produced by the Institute of Supply Management, after jumping from 54.9 to 58.4 in January, retreated to 56.5 in February.

"A PMI above 50 indicates that the economy is expanding, but the 1.9 point slip indicates that the expansion may be losing steam," Slaper said. "Until the most recent PMI release for activity in February, the trend in the index had been positive for six months."

The Federal Reserve continues its policy of keeping the federal funds rate at close to zero. "The Committee [that sets Fed policy] will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period," according to the March 16 Federal Reserve press release.

"The historically low federal funds rate presents some thorny questions in terms of the interest rate spread, one of the components of the LII," Slaper said. "The continued large spread may send false signals in the post-bubble, financial-crisis world. If the banking sector is weighed down by too many bad loans or is loath to lend because of a continuing economic climate of uncertainty, then monetary policy loses its clout.

"Thus, the interest rate spread may be one of the best indicators for signaling a downturn, but one needs to use it with caution in the current economic environment," he added.

The auto sector component of the index continues to show an industry in the doldrums. The data series -- unfilled orders of motor vehicles and parts -- has been uneven, but fundamentally flat. That said, shipments of motor vehicles and parts did show a marginal increase from December to January. In addition, January's shipments were almost 10 percent higher than a year ago.

About the Leading Index for Indiana
The LII, developed by the Indiana Business Research Center, is designed to reflect the unique structure of the Indiana economy. It is a predictive tool that signals changes in the direction of the economy several months before the economy has changed. In contrast to economic forecasts, which use sophisticated statistical models to foretell particular levels for a wide variety of economic activities and outcomes in the future, a leading index is a simple construct that indicates a general direction of future economic activity expected in the next five to six months.