Blog: The two PMIs and the Fed

The Purchasing Managers Index (PMI) is a measure of manufacturing activity that has become widely followed in the last five years or so. I’ve used PMI data in research for some time, though. I’ve always liked the PMI, because it gives us a view of the economy from those actually working, it is not revised backwards, and it comes out one month in arrears.

But not all PMI data is the same. For the US, there are two indices. The first, published by the Institute for Supply Management (ISM), has a long history going back to 1948. A more recent PMI is published by Markit, which started in the UK but now publishes PMIs for over 30 countries, including the US. The Markit US PMI uses the same survey data as the ISM (through a mutual agreement), yet the results are not always the same.

The media tends to pick and choose which version they use, so when the two indices diverge, they choose the one that seems to fit the current narrative about markets. This month, the Markit US PMI rose, indicating an acceleration in manufacturing. The ISM version declined, indicating a slowdown in manufacturing. Importantly, both were signaling that we are still in a manufacturing expansion. Yet, the media latched onto the message that the US was slowing, signaled by the ISM PMI, and mostly ignored the Markit PMI. In other months, that’s been reversed. So what are the differences between the two PMIs, and what does it mean when they diverge?

Both PMIs survey purchasing managers in five categories: new orders, production, inventories, employment, and delivery times. The ISM equally weights the five categories, while Markit gives more weight to new orders, production and employment. Markit states that these categories are more forward-looking, so their weighting scheme makes the PMI more of a leading indicator than a coincidental one.

If this is true, the current divergence suggest that while the US economy is slowing (ISM’s result), the prospects still look good for the future (Markit’s result), and the US economy is still growing at a strong pace (both indicators). But even the ISM PMI indicates that the Fed will need substantial rate hikes if they intend to ease off the monetary accelerator. That is not the story being shared, but it’s the important takeaway from the two PMIs.

Reprinted from the First Quadrant "Brim Shots" blog.