Is PMI a Good Leading Indicator for Fluctuations in FX Markets?
The Purchasing Managers' Index (PMI) is widely recognized as a leading indicator of economic growth, often used for nowcasting macroeconomic variables like GDP. But can it help us understand how participants in the foreign exchange (FX) market shape their expectations about future economic data, and does it act as a leading indicator for FX markets?
Using PMI data from June 2013 to April 2024 for the Eurozone, U.S., U.K., and Japan, I empirically tested whether PMI spreads (Domestic Currency PMI - USA PMI) can forecast exchange rate changes. Here are the key findings:
Eurozone and UK PMI Spreads: A wider PMI spread in the Eurozone and UK correlates with Euro appreciation against the dollar, inline with broader macroeconomic models.
Japanese Yen Dynamics: The Japanese yen shows an inverse relationship with its PMI spread, likely influenced by Japan's prolonged negative interest rates.
Interest Rate Spreads: Adding three-month interest rate spreads doesn't enhance the EUR and GBP models but reveals significant predictive power for the JPY, underscoring Japan's significant role in global capital markets and the carry trade dynamics.
Overall, while PMI spreads, especially their six-month moving averages, have some predictive power, this relationship varies among currencies. PMI's predictive value is limited for short intervals, emphasizing the need for continuous model reassessment due to the complexity of exchange rate behavior.
For those interested in a deeper dive or discussion on this topic, feel free to connect with me! You can find a copy of my paper here. I'm also happy to share my code if you'd like to explore this subject further.