Keeping an Eye on the Economy

Watching key economic indicators over time should help you understand the signals the economy is sending. While you may not make financial decisions with certainty, understanding the economy should help you make decisions, such as which investments to purchase and sell, when to lock in mortgage rates, and when to purchase major durable goods, with more confidence. Some of the more important statistics to track include:

Interest rates.
At a minimum, follow the prime rate, Treasury bill rates, and Treasury bond rates.

• The prime rate is the rate banks charge their best business customers. Since many consumer loans are tied to the prime rate, following this rate will indicate whether your personal borrowing costs are likely to increase or decrease.
• Following Treasury bills and bonds will help you determine trends in short- and long-term interest rates. Check these rates at least monthly.
• Study the yield curve, which is a graph plotting interest rates for the same type of bond for a series of maturities, usually ranging from three months to 20 or more years. Changes in the yield curve's shape can signal a change in the economy's direction. In general, a normal upward sloping curve indicates a healthy economy, a steep upward sloping curve often occurs at the beginning of an economic expansion, a flat curve may indicate an economic slowdown, and an inverted curve typically precedes a recession.

Inflation.
The most common measure of inflation is the consumer price index (CPI), which is announced the fourth week of every month for the preceding month. The CPI is a measure of the average change in prices paid by urban consumers for a fixed basket of goods and services. An annual inflation rate below 2% is considered low, 2% to 4% is moderate, and above 4% is high. Look at the annual rate and whether inflation is increasing or decreasing over time. This is a closely watched statistic since the Federal Reserve is committed to keeping inflation under control.

Gross domestic product (GDP).
GDP is a measure of the goods and services produced by the nation and includes consumer spending, business investment, government spending, and net exports. Approximately three weeks after the end of a quarter, the government announces the annual GDP growth rate. Under 2% is considered low growth, 2% to 5% is considered moderate growth, and over 5% is a boom considered difficult to sustain.

Unemployment.
Statistics regarding unemployment are some of the most timely statistics generated by the government - figures are typically released within a week of month end. Thus, unemployment statistics are closely watched since they quickly signal broad-based changes in the economy. While low unemployment rates generally indicate a strong economy, rates that are too low can cause inflationary pressure. A low supply of workers makes it necessary for companies to increase wages to attract employees. Increasing unemployment rates, on the other hand, can signal that we are headed toward recession.

Corporate profits.
How well businesses are performing is an important indicator of the economy's overall health. A common measure of corporate profits is earnings per share for the Standard & Poor's 500. Comparing this figure to year ago numbers indicates whether profits are increasing or decreasing.

While you may not be able to predict where the economy is headed with certainty, following key indicators will provide some direction.