Purchasing Managers’ Index: How PMI Works?

The Purchasing Managers' Index (PMI) is one of the most important economic indicators that provides insight into the current state and future trends of an economy.

It is particularly effective in forecasting macroeconomic indicators such as economic growth, inflation, and employment which are observed by investors, economists, and central banks.

What is the Purchasing Managers’ Index (PMI)?

The Purchasing Managers’ Index (PMI) measures the current conditions and future expectations of businesses operating in the manufacturing and services sectors of an economy.

The PMI data reflects the performance of the manufacturing and services sectors within an economy, compiled from survey responses of purchasing managers working in these sectors. The responses cover key business areas such as new orders, employment, supply chain performance, and production levels, and these data points are aggregated to calculate the PMI value.

PMI is usually calculated for two main sectors: Manufacturing PMI and Services PMI. Its value is generally interpreted relative to the 50 level. Values above 50 indicate growth in the relevant sector, while values below 50 indicate contraction.

How to Calculate the PMI? The PMI Formula

This specific index is calculated using data collected from purchasing managers in businesses within a specific sector. In this process, purchasing managers are asked questions regarding five main categories of business activities. These categories reflect the key factors that refer to how strong or weak production activities are.

The PMI calculation is based on the following five key components:

• New Orders: Measures whether the number of new orders received by businesses has increased or decreased.
• Production: Determines if production levels have increased or decreased compared to the previous period.
• Employment: Indicates whether businesses are hiring new employees or reducing their workforce.
• Supplier Deliveries: Shows whether suppliers are delivering products faster or slower than before.
• Inventories: Analyzes the changes in the stock levels of businesses.

The data collected from these categories is used to calculate the PMI value based on the following formula:

PMI = (P1 + P2 + P3 + P4 + P5) / 5 

Each category is measured using three main response options:

• Improved: Positive sign (+)
• No Change: Neutral (0)
• Deteriorated: Negative sign (-)

PMI Calculating Example

Let's assume the following responses were collected from a business survey:

• New Orders Increased: 60%
• Production Increased: 55%
• No Change in Employment: 50%
• Supplier Deliveries Slowed Down: 45%
• Inventories Increased: 52%

These values are weighted and calculated according to the formula to determine the PMI value. In this case, a PMI value of 52.5 indicates that the sector is still growing, but the growth is not very strong.

How to Interpret the PMI?

The Purchasing Managers' Index (PMI) provides valuable insights into the current state and future direction of an economy or sector. The PMI value can range between 0 and 100:

• Values Above 50: Indicates growth in the relevant sector. For example, a PMI value of 55 signifies an increase in key factors such as production, orders, and employment.
• Values Below 50: Indicates contraction in the sector. For instance, a PMI value of 45 may be interpreted as a decrease in orders, reduced production, and slower supply chains.
• Exactly 50: Indicates no change and suggests that the market is stagnant.

Since PMI data is released monthly, tracking changes over time is important. For example, if the PMI was 53 last month and drops to 48 this month, it can be interpreted as a signal of economic slowdown or contraction. Similarly, a rising PMI value suggests economic improvement.

How to Use the Purchasing Managers’ Index?

PMI can be used in both short-term and long-term investment decisions as it provides insights into key macroeconomic factors such as economic growth, employment, inflation, and supply chain conditions.

Understanding Market Sentiment

PMI data helps traders understand the general economic sentiment in the market. For instance, a PMI reading above 50 indicates that the market has a positive outlook and that economic growth is ongoing. In such cases, traders may consider taking more risky positions in stocks or currency pairs.

Using PMI in the Forex Market

Forex traders may use PMI data when trading currency pairs. A strong PMI report often increases demand for that country’s currency and can trigger an upward movement in currency pairs.

For example, a strong PMI report from the U.S. could lead to the USD gaining value against the EUR, GBP, or JPY. On the other hand, a weak PMI report may result in a depreciation of the country's currency. Examining PMI reports as soon as they are released can help traders make timely decisions in short-term trades.

Using PMI in the Stock Market

PMI is an important indicator for assessing the performance of companies in the manufacturing and service sectors. A high PMI reading suggests that these companies are receiving more orders, increasing production levels, and hiring more employees. This positive performance can boost stock prices and create buying opportunities for investors.

On the other hand, a low PMI reading indicates that companies are experiencing slower growth and declining sales. This can increase selling pressure on stocks and cause investors to take more cautious positions.

Impact on Interest Rates and Central Bank Policies

Central banks take PMI data into account when setting monetary policies. A strong PMI reading signals rapid economic growth and rising inflation risks. In such a case, central banks may raise interest rates to cool down the economy.

However, a weak PMI report may prompt central banks to adopt more accommodative monetary policies and lower interest rates. In this scenario, traders might shift their focus to riskier assets to take advantage of market opportunities.

What Are the Results of the Current Purchasing Managers' Index?

• When the PMI data is announced above 50, it indicates that economic growth is continuing. In particular, expansion in the manufacturing and services sectors can be a sign of economic improvement.
• A strong PMI figure shows that businesses are receiving more orders and may hire new employees as a result. This can positively impact unemployment rates.
• A high PMI figure can strengthen the currency of the respective country. For example, a strong PMI report from the U.S. can lead to the USD appreciating against other currencies.
• Strong PMI values positively impact the performance of companies, especially in the manufacturing and services sectors. This can drive their stock prices higher.
• The PMI data helps investors form a general perception of the market. High values create a positive market sentiment, while low values lead to uncertainty and risk aversion.
• A weak PMI figure may indicate delays in the supply chain and longer delivery times. This can slow down the production processes of businesses.
• High PMI values suggest that prices may rise and inflationary pressures may increase.
• Strong PMI data generally improves consumer confidence and supports economic activity.

FAQ

What Is the Global PMI?

The Global PMI is an indicator that measures the condition and economic trends of companies operating in the manufacturing and service sectors worldwide. 

What Does a High PMI Reading Indicate?

A high PMI means that new orders are increasing, production levels are rising, and businesses are hiring more employees. This shows that the economy is progressing healthily, and businesses have positive expectations for the future. Additionally, such high values signal increased consumer and investor confidence. However, excessively high values may also suggest that inflationary pressures are increasing.

How Does the PMI Affect Forex Markets?

A strong PMI reading can positively impact a country's currency because it signals economic growth and stability. For example, a strong PMI report from the U.S. may cause the U.S. dollar to appreciate against other currencies. A weak PMI reading can also lead to the depreciation of the respective country's currency. Forex traders monitor this data to take advantage of short-term price movements.

How Does the PMI Affect Stock Markets?

A strong PMI acts as a positive signal for traders, increasing the demand for stocks and pushing stock indexes higher. On the other hand, a weak PMI report may raise concerns that companies' revenues could decrease. Companies operating in the manufacturing and service sectors are particularly affected by these reports.