PMIs: perpetually misleading indicators?

Here’s some reaction to this morning’s European flash purchasing managers' indices (PMIs).

From Capital Economics:

The rise in the eurozone flash Composite PMI in June confirms that economic output in the region is recovering rapidly from April’s nadir as restrictions are progressively eased.

And ING-DiBa:

Today’s PMI numbers provide further evidence of what initially looks like a textbook V-shaped recovery. As much as more than a month of (full) lockdowns had sent economies into a standstill, the gradual reopenings of the last two months have led to a sharp rebound in activity.

Everything back to normal then? Not quite.

The actual reading for the eurozone was 47.5. Even though that was way above the 31.9 figure for May, it means the headline PMI remained below the “magic” 50 level that is supposed to separate an expansion from a contraction for the third month in a row.

A further contraction on top of what happened in April and in May is hardly what you’d imagine for June, given that lockdown measures have continued to ease substantially across much of the continent. In fact, we’d go as far as to say there is absolutely no way that official data will show that output fell between April and May, and May and June (something that Chris Williamson, chief business economist at IHS Markit, which constructs the PMIs, has acknowledged too).

So does the PMI need renaming as the Perpetually Misleading Indicator?

There certainly does appear to be a problem here. The main question IHS Markit poses to purchasing managers is whether or not activity improved this month compared with the previous month. The fact that, on average, purchasing managers across Europe believe conditions in April were not the nadir and that matters became even worse in May and June seems very odd to us indeed.

There are some compelling reasons why the headline PMI readings aren’t rising above the 50 level despite common sense suggesting output must have increased as lockdowns eased. That we are experiencing a demand and supply shock could be distorting the headline reading due to the way in which the subindices, which measure everything from job losses to delivery times, feed into the main number. The main distortion comes from the fact that delivery times tend to move in the opposite direction to the headline reading — the reason being that in normal times slower deliveries reflect high demand and not border closures (more on that here).

The problem is that leaving people to weed out the nuance and place whatever weight they feel like on the various sub-readings leads to myriad interpretations of the data.

Via Frederik Ducrozet of Pictet:

Via Julian Jessop  (commenting on the UK data, but which shows a similar trend):

We particularly liked this from Reuters’ Andy Bruce:

So where does the truth lie? From Richard Barwell of BNP Paribas Asset Management:

If you understand how the PMI is constructed then the data imply an L shaped recovery, if you just look at the numbers they imply a V shape and the truth is somewhere in the alphabetical chasm between. Investors are trying to figure out the question that would make sense of the answers given what we think happened to the economy between April and June.

Ie, this is anyone’s guess.

We don’t want to single out just the PMIs here. Inflation data are going to look pretty fuzzy too. We’ve had a seismic economic shock — it’s bound to lead to readings being difficult to interpret. The key is going to be ensuring that this fuzziness is well understood by the policymakers who need to work out what is actually going on here in order to make decisions. From the reactions to the PMIs, we’re far from confident that’s going to be the case.

Related links
The European PMIs look troubling - FT Alphaville