Reading PMIs: the diffusion index that leads everything else
Purchasing managers surveys arrive weeks before hard data and move currencies more than their sample size deserves. The trick is knowing what a diffusion index can and cannot tell you.
Key takeaways
- – A diffusion index measures direction of change, not magnitude – fifty means no change, not zero growth
- – Sub-components, especially new orders and prices paid, lead the headline
- – PMIs move markets because they are early, not because they are precise
Purchasing managers indices ask a panel of businesses whether conditions this month are better, worse or the same as last month. The result is a diffusion index: the share reporting improvement plus half the share reporting no change. Fifty means as many firms improved as deteriorated.
The most common misreading
A reading of fifty-two does not mean the economy grew two percent. It means slightly more firms saw improvement than deterioration. A diffusion index captures breadth of change, not size of change, so a small number of firms improving dramatically registers the same as a small number improving marginally.
The corollary matters: a fall from fifty-eight to fifty-three is not contraction. It is slower expansion. Markets frequently trade that fall as though it were bad news in absolute terms, which creates the reversal that follows once the detail is read.
The sub-components that lead
The headline is a composite, and the parts move at different times.
- New orders – the closest thing to a forward-looking element. New orders turning down while the headline holds up is the classic early warning.
- New orders minus inventories – a useful spread. Orders falling while inventories build means production has to slow.
- Prices paid – an early read on input cost pressure, and the component most likely to move rate expectations.
- Employment – noisier, but it leads official labour data.
Why they move currencies
PMIs are published within days of the month ending, well ahead of official statistics. In a market pricing central bank policy continuously, being early beats being precise. A PMI that shifts the expected path of rates moves the front end of the curve, and the currency follows.
Flash estimates, released before the final figure, tend to produce the larger reaction because they contain the new information. The final print usually confirms and does little.
Cross-checking
Manufacturing PMIs get the attention, but services dominate most advanced economies by output and employment. When the two diverge, the services reading usually matters more for policy – and manufacturing usually matters more for commodity currencies and for global trade sentiment.
Times and consensus figures for every release are on our economic calendar.
