Understanding the Purchasing Managers Index (PMI)
As we continue to study the components of the global economy that we have at our disposal in regards to understanding the forex market, one element we should consider is the Purchasing Managers Index, or PMI for short.
The PMI is a survey of purchasing managers of prominent organisations, used to assess their sentiment on the current market conditions. It is organised by sector and country, so popular examples include the ‘US Manufacturing PMI’ or the ‘UK Services PMI.’ The results from the survey are collated and normalised into a single figure, which explains why this has been classified as an index. Typically, readings above 50 are considered to be signs of an expansion when compared to the previous month, whilst those below 50 are considered contractions to the previous month. Most PMIs also come with a corresponding forecast value, as a level at which market experts believe the actual figure should be, so we need to compare these two figures as well in order to determine how we think sentiment will sway our forex rates.
So what’s the logic behind the PMI and its relationship with forex? The first thing to consider is the role of the purchasing manager, which is, as the name suggests, to purchase the goods and services required for the company to function. In manufacturing companies, this will usually be the procurement of raw materials required to make the final products. In services organisations such as investment banks or boutique trading firms, this could be purchasing subscriptions or licenses to 3rd party financial providers such as Bloomberg, Reuters etc.
The point that we can glean from this is that the purchasing manager is on the ground level of company operations and he has the information to understand how healthy a company is. He is provided with the monthly, quarterly and/or yearly budgets from the company directors and changes in this value can be highly indicative of past and expected future performance of a company. It’s not as simple as smaller budget = uncertain future, because companies may be able to afford to reduce their expenditure dependent on the phase they’re currently going through or if they have found cheaper costs of production, but purchasing managers will be informed of reasons as to why the budget is changing. Getting this information condensed into a numerical format can therefore be extremely useful in understanding what the future of a certain sector might look like.
The PMI figures are released on a monthly bases with the following schedule:
Manufacturing PMI - first working day of the month
Services PMI - third working day of the month
Whole Economy PMI - third working day of the month
We keep a track of these results on the Algo-Fin twitter channel. Every weekend, I run a Python script that takes market data and provides a summary of performance over the previous week. Alongside this, I include a table of the previous week’s economic announcements and their results along with the outlook for the following week. It’s a convenient way for you to add information to your trading plans at the top of each week by checking these tables and adding the release dates to your calendar.
To round this article out by bringing it back to the forex markets, the relationship we are expecting is that healthy companies leads to healthy economies which results in a rise in the value of a currency. As with every individual economic component that we discuss on this channel, it has to be mentioned that this relationship is never perfect. With all the different forces at play in such a complex relationship, we can’t rely on one single indicator to provide us with an entire picture of a market. Research has shown however, that the PMI releases are paid very close attention to by institutional investors and there has to be a reason for this. It has often been seen as a leading indicator due to the time lag it takes for purchasing managers’ sentiment and actions to filter into the market. Next week, I will present some of the visualisations from PMIs around the world that will take a deeper look into this proposition.