The currency of a country with a more developed economy will have a higher value. Successful traders often take advantage of this to invest profitably. However, how can we measure the economic development of a country? Follow the following article to understand and know how to take advantage of it, the PMI index will be a powerful tool to help you answer the above question.
What Is the Purchasing Managers’ Index (PMI)?
The PMI is like a monthly “health report” for the economy. It tells us whether manufacturing and services are improving or deteriorating.
The PMI is not just a number, but also a “compass” that helps us navigate the foreign exchange market.
- Currency strength: When a country’s Purchasing Managers’ Index increases, it means that the economy is “healthier”, businesses produce more and demand for goods and services also increases. At this time, the country’s currency is often more popular, the value increases. Conversely, a low PMI shows that the economy is in trouble, demand decreases, and the currency tends to depreciate.
- Interest rates and capital flows: PMI also affects interest rates. When Purchasing Managers’ Index is high, interest rates often increase, attracting foreign investors looking for high returns. This further increases the value of the currency. Conversely, a low Purchasing Managers’ Index accompanied by low interest rates causes investors to withdraw capital and the currency depreciates.
- Commodity prices: When PMI increases, it means that the economy is “heating up”, businesses are producing more, and demand for goods is high. At this time, prices of goods, especially the country’s main export goods, tend to increase. On the contrary, a decreasing Purchasing Managers’ Index shows that the economy is “cooling down”, demand is decreasing, causing prices of goods to also decrease.
- Inflation: When demand increases, pressure on prices also increases, leading to inflation. On the contrary, when demand decreases, inflation will be contained. To deal with inflation, central banks often adjust interest rates. Increasing interest rates will help reduce demand and contain inflation, but at the same time, it can also make the country’s currency more attractive to foreign investors.
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What is included in PMI?
The Purchasing Managers’ Index is an overview of a country’s manufacturing situation. To draw this picture, people will collect information from businesses through a survey.
Usually, the survey will focus on the following 5 main factors:
- New orders: This means that businesses are receiving many new orders or not. If new orders increase, it proves that market demand is increasing.
- Output: Output is output, that is, businesses are producing more goods or services or not.
- Hiring: Are businesses hiring more employees or not? This shows whether production demand is increasing or decreasing.
- Supplier delivery time: If suppliers deliver slower, it may be due to increased demand for raw materials, leading to a shortage.
- Inventory: If inventory increases, it may be due to more production than market demand.
How does PMI affect a country’s currency?
Purchasing Managers’ Index, is an important indicator of a country’s economic health. So how does PMI affect the forex market?
- Investor sentiment: When Purchasing Managers’ Index is positive, investors become more optimistic about the country’s economic outlook. This often leads to an influx of capital, pushing the value of that country’s currency up. Conversely, a negative Purchasing Managers’ Index can cause anxiety, causing investors to withdraw capital and the currency to depreciate.
- Country comparison: Traders often compare Purchasing Managers’ Index of different countries to look for trading opportunities. For example, if country A’s PMI is rising sharply while country B’s Purchasing Managers’ Index is falling, traders can buy country A’s currency and sell country B’s currency.
- Part of the big picture: Purchasing Managers’ Index is just one of many important economic indicators. To make accurate trading decisions, traders need to combine Purchasing Managers’ Index with other indicators such as GDP, CPI, and unemployment rate.
How is the Purchasing Managers Index calculated?
PMI is like a thermometer for the economy. When Purchasing Managers’ Index increases, we can understand that the economy is doing better.
How to calculate PMI
Business survey: Every month, organizations like the Institute for Supply Management (ISM) will send questionnaires to hundreds of businesses large and small across the United States.
Collecting information: Businesses will answer questions about their business situation over the past month, including:
- New orders: Are there many new orders?
- Inventory levels: Are inventories increasing or decreasing?
- Production: Is production increasing or decreasing?
- Supplier deliveries: Are suppliers delivering faster?
- Employment: Are more employees being hired?
Calculating the index: Based on the answers, experts will calculate a number from 0 to 100, called the PMI index.
Analysis of results
- PMI > 50: The economy is expanding, businesses are doing well.
- PMI < 50: The economy is declining, businesses are facing difficulties.
- PMI = 50: The economy has not changed much compared to the previous month.
PMI calculation formula
The Purchasing Managers’ Index calculation formula seems a bit complicated, but it is actually very simple:
PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)
In which:
- P1: Is the percentage of businesses that responded that their business situation is improving (eg: orders increase, production increases). This part is multiplied by 1 because it shows a clear growth.
- P2: Is the percentage of businesses that responded that their business situation has not changed. This part is multiplied by 0.5 because it shows stability, no growth or decline.
- P3: This is the percentage of businesses that responded that their business situation is deteriorating (e.g., orders are down, production is down). This part is multiplied by 0 because it shows a decline.
For example: Suppose there are 100 businesses participating in the survey:
- 60 businesses reported an improvement (P1 = 60%)
- 30 businesses reported no change (P2 = 30%)
- 10 businesses reported a deterioration (P3 = 10%)
Then, the PMI will be calculated as follows: PMI = (601) + (300.5) + (10*0) = 75.
In the above example, with PMI = 75> 50, we can conclude that the economy is in a growth phase.
Using the PMI
The PMI index is not just a dry number on a report, but it is also a useful tool widely used in many fields, especially in the investment field.
- Risk assessment: Investors can use PMI to assess the risk of investments. If Purchasing Managers’ Index decreases, it means that the economy is in trouble, investments in stocks or bonds may carry higher risks.
- Choosing an investment industry: PMI helps investors choose industries with development prospects. Industries with high Purchasing Managers’ Index often have better growth prospects.
Conclusion
In conclusion, the PMI is a measure of the health of an economy. It provides an overview of the production and service situation of an economy, helping investors, businesses and governments predict market trends and make appropriate decisions.
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