While the coronavirus pandemic is hitting the global economy, and GDP is reflecting the extent of damages with a delay, leading indicators come out on top. In this article, we are going to take a closer look at one of these indicators — Purchasing Managers’ Index (PMI). Let’s find out what it is, how to interpret its values correctly, and how it impacts the exchange rate.
The PMI belongs to leading economic indices (indicators) that are also known as surveys. It is leading because its value shows how the situation will (or may) unfold in the future.
This indicator is based on a survey of purchasing managers at large companies. In this case, the questions relate to the number of orders, employment details, production output, export and import prices, and warehouse stocks. In addition, managers are asked to rate whether the situation in their business area improved, worsened, or remained the same. The responses help shape the final indicators.
We measure the PMI values from zero to 100. However, there is a ‘watershed,’ i.e., 50 points. If the index is above this value, the economy will keep growing. If it is below 50, this is an economic slowdown. Perhaps this is the main thing that you need to know in order to assess your PMI and draw a conclusion about the current economic climate.
In addition, we measure the PMI in two sectors of the economy. The first sector shows what is happening in the production industry, while the second sector gives an idea of what is going on in sectors of the economy and areas that offer services to ensure that the population enjoys decent living conditions.
The exchange rate is more influenced by the PMI that corresponds to the prevailing sector of the economy. In the case of China and Germany, the manufacturing PMI is more important, since the share of the manufacturing sector prevails in GDP. In terms of the USA, where GDP mainly depends on the consumption sector, the services PMI has a greater impact on the exchange rate.
KEEP IN MIND:
As you know, the market is driven by expectations. Therefore, when most important macroeconomic indicators become available, we see a local surge in volatility if the actual value does not match the forecast.
When we consider the PMI (what it is) and its threshold separating growth dynamics from declines, it is important what side of 50 its indicators are on.
E.g. Before the trade war between the US and China and prior to the coronavirus crisis, the major developed countries had PMI values well above 50. In this case, minor deviations from forecasted values virtually did not impact any exchange rates.
However, when the PMI reaches 50 and crosses this ‘watershed’, the market perceives the situation more sensitively, as it becomes clear that the economy moves from the growth stage to the decline one.
It should be noted that an economic slowdown in China and Germany due to the trade war was first proved by the manufacturing PMIs. These were the first wake-up calls, even before GDP indicators showed a slowdown. When the quarantine measures were mitigated, the revival of businesses was proved by the PMI as well.
Let’s take a look at the most interesting PMIs: China, Germany, and the USA.
China is known to be the world’s largest manufacturing-based economy. An industrial slowdown in China suggests that GDP growth will be hit hard.
When the USA set off the trade war against China in the second half of 2018, it backfired on the manufacturing sector. The imposed duties meant that it became less profitable for China to manufacture goods for export to the USA. The manufacturing PMI (China) demonstrated a decline: it reached 50 in November 2018 and 49.40 in December.
Monthly values: 49.50 in January 2019 and 49.20 in February. In 2019, the China manufacturing PMI was mostly below 50, as trade relations between the USA and China were strained.
At the end of 2019, China faced a new challenge — the COVID-19 outbreak. Tough quarantine rules were introduced in early 2020, the economy stalled out, and the manufacturing PMI dropped to 37.50 in February. However, China was the first to overcome a COVID-19 wave, and the manufacturing PMI reached 50.90 in June, which, as you already know, means that this sector of the economy is moving to the growth stage.
Germany manufacturing PMI. The economy of Germany has a large manufacturing sector as well. Moreover, the economy of Germany with its manufacturing sector is the powerhouse of the entire eurozone economy.
The China-United States trade war has disrupted supply chains and has affected the manufacturing sector of Germany. Back in November 2018, the Germany manufacturing PMI was at 51.80 and 44.30 in May 2019! (44.30 are well below 50, and this means that the manufacturing sector has been seriously affected).
Meanwhile, the European Central Bank has been discussing the monetary policy measures, such as the possibility of launching a quantitative mitigation program that could protect the economy from the crisis.
The coronavirus pandemic has resulted in a slowdown in the manufacturing sector of Germany. The PMI dropped to 34.40 in April.
Italy services PMI. Despite the fact that the economy of Italy is not as influential in the eurozone as the economy of Germany, the services PMI of this country clearly shows how the index changes during the crisis. Italy is known to be the hardest hit by the coronavirus pandemic. And since the service sector prevails over the manufacturing one, the non-manufacturing PMI will be the most significant indicator.
The Italy services PMI was 51–52 before the pandemic and dropped to 17.40 in February (17.40, Carl! This is the most severe crisis!).
US PMIs. In conclusion, we should be paying special attention to the US PMIs. In the USA, the Institute for Supply Management collects data and calculates these leading indexes. Therefore, the US PMIs are often referred to as the ISM or the ISM PMI. The formula, watershed (50 points), and interpretation principles are similar to other PMIs.
We need to keep in mind that the US economy is a consumer economy, which means that the US ISM non-manufacturing PMI is more important and has a greater impact on the US dollar rate.
To recap, the market pays more attention to the ISM when the index exceeds 50.
During the quarantine caused by the coronavirus pandemic, these indicators dropped well below 50. The US ISM manufacturing PMI dropped to 27.0 in April, and the US ISM non-manufacturing PMI reached 36.90.
As we already know, the PMI dynamics can impact the exchange rate. However, these indicators are not always taken into account by the market. Sometimes they are skipped if investors are focusing on more important factors or events, e.g., trade wars, more people infected with COVID-19, labor market statistics.
Here are a few key points to consider when trading PMIs:
PMI is a vital economic indicator that shouldn’t be overlooked. Macroeconomic calendar and reviews that we publish on a weekly basis can help you track it down. Use this data to trade profitably.