Global Daily – Why are PMIs still pointing to falls in activity?

by: Aline Schuiling , Bill Diviney

Global Macro: Eurozone and US PMIs pick up, but still point to contraction – Both eurozone and US flash PMIs were released earlier this week, and while picking up significantly, still remained below the key 50 mark – i.e. they still point to a month-on-month contraction in activity. The eurozone manufacturing PMI increased to 46.9 in June, up from 39.4 in May, while the services PMI rose to 47.3, up from 30.5 in May. For the US, the manufacturing PMI picked up to 49.6 from 39.8, while the services PMI rose to 46.7 from 37.5.

PMIs aren’t telling us very much in the current environment – The PMI is calculated as a diffusion index of the sum of the percentage of ‘higher’ responses to a survey question and half the percentage of ‘no change’ responses. As such, a reading above 50 indicates an overall increase in activity compared to the previous month. However, we already know from hard data (industrial production and other indicators) for May for instance that activity has recovered following the easing of lockdown restrictions, whereas the PMIs still pointed to massive contractions in May. If the PMIs properly reflected the pickup in activity, they ought to be well above 50 by now. Why are they not? We suspect that there are issues with how the surveys are being answered, with respondents perhaps comparing current activity to pre-pandemic levels rather than the previous month. This would make the current PMIs somewhat more comprehensible, although still not very helpful in gauging what is going on in the economy (except perhaps as a sentiment indicator).

Activity is nonetheless still very weak, and likely to remain so – As mentioned above, the fact that the PMIs remained below 50 in June reflects the fact that the unique and unprecedented reason of the economic contraction in March and April (lockdowns) means such surveys need to be taken with a pinch of salt at the moment. It also suggests that the link between the level of the PMI and GDP growth may have weakened. Still, more fundamentally, we think that the low level of the PMIs also reflects weak business sentiment, which is likely to have a longer-term negative impact on economic growth. Indeed, we expect the eurozone economy to move back into recession during the final quarter of this year and the beginning of 2021, after an initial technical rebound in GDP growth in Q3. For the US, we expect activity to remain well below where it would have been absent the pandemic, even by the end of next year. These longer-term drags on GDP are expected to be the result of rising corporate bankruptcies, sharp rises in unemployment, deteriorated financial conditions and supply chain disruptions that will continue to weigh on consumer spending, fixed investment, world trade and the global industrial sector. The forward looking components of the PMIs also underline these ongoing weakness. For instance, for the eurozone the new orders component of the manufacturing PMI came in at 45.2 in June and the new export orders at 42.5, so each are well below the 50 boom-bust mark. Another sign of weakness is the employment component of the composite PMI, which came in at 43.1 in June. At this level it is consistent with sharp falls in employment in the coming quarters.