Trading News for Beginners – About the Purchasing Managers’ Index

September 08, 2022 14:57

This article is about the Purchasing Managers’ Index (PMI). Learn about the roots of the PMI and how this important indicator can give us vital information about the direction of an economy and underlying currency. Read on to find out:

  • What is a Purchasing Managers’ Index?
  • How did the Purchasing Managers’ Index start?
  • What is the United States ISM Manufacturing Index?

Economists from the 1800s to the 2000s have puzzled over the forces that drive economic booms and busts. Over time, it became apparent that economic cycles were driven by supply and demand.

During the 1700s, the Industrial Revolution spread to the world from Britain. The manufacturing sector quickly grew bigger than the agricultural sector and started producing much of the cash circulating in the economy and contributing to tax revenues. But economic booms and busts still took governments and populations by surprise because they seemingly appeared from nowhere.

How did the Purchasing Managers’ Index start?

In 1913, someone in the United States had the bright idea of asking the people directly involved in supply and demand: the purchasing managers. That someone was a financial and business publishing salesman named Elwood B. Hendricks.

Hendricks’ logic was sound and he had gone to the heart of the matter. Purchasing managers are in charge of buying all the supplies such as raw materials and fuel needed for factories and information from them can act as an early warning of a recession. Feedback from purchasing managers can also indicate an upturn in the economy or status quo, in other words, no change whatsoever.

What is the United States ISM Manufacturing Index?

Hendricks’ belief in the economic value of purchasing managers motivated him to build an association for these professionals that evolved over the decades into the US Institute of Supply Management (ISM).

The ISM has an estimated 50,000 members in 90 countries at the time of writing, each of them with a finger on the pulse of manufacturing and services. Purchasing managers in different parts of each sector are asked about supply-and-demand aspects of their business each month and give one of three responses: better, same or worse.

The answers are modelled into an index from 0 to 100, where a reading over 50 means that demand is on the rise and a reading under 50 means a contraction in demand.

Similar approaches are taken by other private and public entities that carry out PMI research, including S&P Global (formerly IHS Markit) and central banks like the Bank of England.

What do PMIs mean?

PMI surveys carry a wealth of information about the level of supply and demand and are accompanied by written analysis of the results. PMIs act as an early warning for recessions when demand for goods and services falls because of a reduction in cash flow around the economy. These early warnings are used to inform investment and trading decisions on an array of raw materials all the way from agriculture to zinc.

Are PMIs leading or lagging indicators?

At the macroeconomic level, PMIs are seen as leading indicators that provide some insights into the future because between them, manufacturing and services account for around 75 percent of the US economy.

What assumptions can be made using PMI reports depends on the type of trader and their preferences, but in general they include the following:

  • PMIs under 50 indicate it’s time to prepare for a possible recession in the wider economy.
  • PMIs over 50 indicate the wider economy is in a growth phase.
  • A possible recession could weigh on the value of the national currency versus other currencies.
  • A period of growth could support the value of the national currency.
  • Recessions and growth cycles affect commodity prices.

These assumptions depend on other economic conditions and must be viewed in context and not in isolation. An exception to the above, for example, can be seen in the US economy at the time of writing when key PMI surveys remain above the level of 50 but there is a technical recession. This is because the labour market is strong with plentiful jobs to fuel demand for goods and services.

Which PMIs should traders monitor?

Forex traders looking for insights into the performance of an economy could monitor composite PMIs surveying the manufacturing and services sectors. Composites show the big picture direction of the economy and could indicate support or resistance for the value of the currency.

Those who prefer trading CFDs on commodities like metals used in industrial processes could focus on the relevant PMIs from the manufacturing sector in search of clues as to demand and prices. Energy CFD traders could take many cues from industrial PMIs indicating the level of demand for fossil fuels used to power factories and transportation.

To conclude this article, over 40 countries report PMIs which are red-flagged trading events that every newcomer to trading should learn about and observe before deciding how to fit them into their goals and trading strategies.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

Sarah Fenwick
Sarah Fenwick Financial Writer, Admirals London

Sarah Fenwick's background is in journalism and mass communications. She has worked as a correspondent covering Swiss Stock Exchange news and written about finance and economics for 15 years.