Purchasing Managers' Indices: Diffusion Indices, ISM versus S&P Global and the Euro-Area PMIs

What you will learn

• How a diffusion index is calculated and why 50 is the dividing line.
• How the ISM and S&P Global manufacturing PMIs are built from sub-indices and why they can disagree.
• Which sub-indices lead and which lag, including prices paid and supplier deliveries.
• How to read the euro-area and German flash PMIs and their limits as GDP predictors.

Explanation

Diffusion indices. A purchasing managers' index (PMI) is a survey of purchasing or supply managers who answer, for each question, whether conditions are higher, the same or lower than last month. The diffusion index for a question is: percentage reporting higher + 0.5 × percentage reporting the same. If everyone reports "the same", the index is 50; above 50 means more firms report improvement than deterioration. The index measures breadth of change, not its size: a firm whose output doubled and one whose output rose 1 percent both answer "higher", which is why PMIs map to growth rates only loosely.

ISM. The Institute for Supply Management (ISM) publishes its Manufacturing PMI on the first business day of the month and its Services PMI two business days later. The manufacturing PMI is a simple average of five sub-indices with equal weights of 20 percent: New Orders, Production, Employment, Supplier Deliveries and Inventories. Supplier Deliveries is read inverted: slower deliveries (above 50) count as positive because they signal busy suppliers, so supply-chain disruptions can lift the composite even as output falls. Prices Paid is published but not part of the composite; it is a fast signal of goods-price pressure. New Orders minus Inventories is a popular leading indicator for production.

S&P Global. S&P Global publishes PMIs for about 40 economies with a common method, which allows cross-country comparison. Its manufacturing PMI weights the sub-indices differently: New Orders 30 percent, Output 25 percent, Employment 20 percent, Suppliers' Delivery Times 15 percent (inverted) and Stocks of Purchases 10 percent. For the US, the two often diverge by several points because samples, weights and wording differ; the ISM sample is tilted towards larger firms. When both move in the same direction, the signal is stronger.

Flash estimates. S&P Global publishes flash PMIs for the euro area, Germany, France, the UK, Japan and the US about a week before month-end, based on roughly 85 to 90 percent of responses; final figures follow at the start of the next month and usually differ by a few tenths. The euro-area flash is often the first broad read on the month and routinely moves the euro and Bund yields. For Germany the manufacturing survey carries extra weight because industry is a larger share of output; the composite PMI is the best single line for GDP tracking.

Reading order. New Orders, Output, the gap between them, Prices Paid and Prices Charged (passthrough), Employment (lags), Backlogs of Work (capacity pressure) and Delivery Times. In services surveys, business activity and new business play the role of output and orders.

Worked example

Hypothetical example, part 1: in a survey, 35 percent of respondents report higher new orders, 45 percent the same and 20 percent lower. Diffusion index = 35 + 0.5 × 45 = 57.5. Reversed shares (20 higher, 35 lower) give 42.5, symmetric around 50.

Part 2, two composites from the same sub-indices. Suppose a month's sub-indices are New Orders 52.0, Production/Output 49.5, Employment 47.0, Supplier Deliveries 51.0 (ISM convention: above 50 means slower) and Inventories/Stocks 48.0.

ISM-style composite: (52.0 + 49.5 + 47.0 + 51.0 + 48.0) / 5 = 247.5 / 5 = 49.5.

S&P-style composite: 0.30 × 52.0 + 0.25 × 49.5 + 0.20 × 47.0 + 0.15 × 51.0 + 0.10 × 48.0 = 15.60 + 12.375 + 9.40 + 7.65 + 4.80 = 49.8 (S&P Global publishes delivery times the other way round and inverts them when building the PMI; the contribution is the same). The higher weight on New Orders makes the S&P reading slightly less weak. New Orders minus Inventories = +4.0, a positive lead for production. Had Supplier Deliveries been 56.0 because of port disruptions, the ISM composite would read 50.5, "above 50", with no improvement in demand.

Common mistake

Practice activity

On paper: a manufacturing survey returns New Orders 46.0, Output 47.5, Employment 49.0, Supplier Deliveries 58.0 (ISM convention, slower) and Inventories 51.0. (a) Calculate the ISM-style composite. (b) Calculate New Orders minus Inventories. (c) Write one sentence on whether the composite flatters the picture.

Key takeaways

• Diffusion index = percent higher + half of percent unchanged; 50 is neutral and the index measures breadth, not size.
• ISM averages five sub-indices equally; S&P Global weights New Orders 30 percent and Output 25 percent, so the two can disagree.
• Supplier Deliveries is inverted: supply disruptions can lift a composite without any demand improvement.
• Euro-area and German flash PMIs arrive a week before month-end and are the first broad read on the month; use the composite for GDP tracking.

Next step

Next we look at GDP itself: its expenditure components, the sequence of estimates, nowcasts such as GDPNow and Germany's quarterly schedule.