Purchasing Managers Index (PMI) and Institute of Supply Management (ISM) surveys

What is it?

Purchasing Managers Index (PMI) surveys in Europe and China, and Institute of
Supply Management (ISM) surveys in the US, are arguably the second most
important pieces of economic data after NFPs.
They are useful for the currency trader for a couple of reasons. Firstly, they are used
around the world and are not just US centric like payrolls, thus they can be a good
gauge of global growth. Secondly, they are a snapshot of business sentiment in a
wide variety of areas like exports, new orders and inventory levels. The results can
be used to predict hiring patterns and also the strength of consumer demand.
PMI and ISM surveys originally focused on the manufacturing sector but as the
manufacturing surveys evolved and grew in popularity they have expanded to the
services and construction sectors. Each country’s PMI survey polls hundreds of
domestic businesses on the level of new orders they have received, order backlogs,
shipment orders, the prices they pay for materials, employment, new export orders
and imports.
In the euro zone the fusion PMI Composite index is an important indicator of the
overall performance of the currency bloc’s economy.
These surveys are conducted around the middle of the month before the data is
released. The result is a diffusion index that measures expansion or contraction in
service and manufacturing businesses. These indexes have values between 0 and
100, with 50 acting as the line between expansion and contraction. A strong release
is above 50, a weak result is below 50.

When is the data released?

Usually the first week of every month (the exact day depends on each country).
China and Europe do things differently and release first and second readings of their
PMI surveys. The first reading is usually the third week of the survey month; the
second reading usually takes place the first week of the next month. However, check
your economic calendar as sometimes the timings can differ.

Why are they significant?

These surveys tend to have a close relationship with GDP data and are a timely
signal of the growth (or lack of) in an economy. As I mentioned at the start of the
chapter, the currency trader is always looking for where growth is strong and also
where it is weak in order to find the best opportunities to go long or short a currency.
ISM and PMI surveys provide this information.

FX market example

The actual PMI and ISM data releases can be good economic data to trade, in
contrast to payrolls. For my part, I find it easier to read them. The index is either
strong (above 50) or weak (below 50). Revisions are only relevant for the euro zone
and China and they tend to be small, thus this is a well-respected and reliable gauge
of economic strength or weakness.
When I trade the actual data release I tend to follow these steps:
1. I know what day and time the data is being released.
2. I find out what the market consensus is – does the market expect a strong or
weak release?
3. I come up with a trade plan. A number around consensus may only have a
limited impact on the market; it’s the outliers that tend to have the capacity
to change trend. I find out the current trading range and look for support and
resistance levels (see technical analysis chapter) that could double up as
breakout zones. I may leave a buy order at the top of the range and a sell
order at the bottom of the range just in case an outlier causes the cross to
change trend.
4. At the time of the release I digest the number and make changes to my orders
if necessary. Your broker should allow you to change orders without a
charge.
A negative surprise in euro zone PMI data
Figure 1.3 shows EURUSD after the release of a weak preliminary reading of the
September 2012 PMI data. The survey was below 50, which dashed hopes that the
euro zone’s struggling economy was starting to recover. This weighed heavily on
EURUSD. As you can see this cross fell from 1.3040 all the way to 1.2920 in the
aftermath of the news.
Although the euro recovered some of the losses during the next day’s trading, this
data is significant for the direction of the euro in the long term. The continued
weakness in the euro zone economy could make some traders think twice before they
put on a long euro trade in the coming weeks as the economic fundamentals look too
weak to support the currency at a higher level.

GBP is also sensitive to PMI data releases. Let’s take a closer look at the UK’s
October manufacturing PMI release on 1 November 2012. There are two ways to
trade this piece of data:
1. Trade the data release itself, or
2. Wait to digest the data and then make your move.
Here is a trade set-up for trading the actual data release.
1. Homework: growth had been strong in the third quarter but the signs
suggested that October had been weak and the strong performance could not
be matched. Thus, there was a growing fear that the data may be even lower
than broad expectations. Indeed, as it happened the data was weaker than
expected for October as it came in at 48.4, whereas the market had expected a
reading of 49.0. Also important to bear in mind was that GBPUSD had traded
higher in the second half of October.
2. A data miss is likely to weigh on GBPUSD, so a sell order could be left
around 1.6100 to benefit from this. As you can see in Figure 1.4, GBPUSD
sold off sharply in the immediate days after the October PMI data miss.

Remember that trading around the data release can be volatile and extra risky, so
this is usually a short-term strategy. A longer-term trader may prefer to trade once
they have digested the release. However, in this example that would have only been
profitable for a couple of weeks. In mid-November market sentiment shifted as risky
currencies like the pound started to rally and the trend changed (see Figure 1.5).