The ISM Manufacturing Index, put out by the Institute for Supply Management, is one of the most prominent releases having to do with the manufacturing sector. It surveys 300 manufacturing firms from 20 industries in all 50 states. The survey gauges the firms on employment, production, new orders, supplier deliveries, and inventories. The five components are combined, weighted, to form the ‘composite’ index – which is the main headline reading reported.
In the ISM manufacturing index, each question is transformed into a diffusion index that is calculated by adding the percentage of positive responses to one-half of the unchanged responses. Therefore any figure above 50 indicates that the manufacturing sector is expanding and is usually associated with healthy GDP growth overall. Manufacturing makes up 13% of US GDP.
A reading below 50 means the sector is contracting. The higher (or lower) the figure, the stronger (weaker) is the activity. Even though the figure falls below 50, it doesn’t necessarily mean that GDP will be negative as well. The point at which GDP turns negative has been pegged near 42.7. Readings in between 50 and 42.7 suggest that manufacturing is declining while GDP is still showing slow positive growth.
The questions in the survey are more general – asking about the general direction – but do not give a quantitative figure. Firms are asked about the general direction of employment – are you adding more hours and workers or not?do you have more orders? are prices higher? but not by how much more or less. A higher reading will mean that more firms are answering yes but then you have to look at other indicators for raw numbers.
Therefore, you can pair this data with indicators like the Industrial Production report or Factory Orders for more raw figures on business activity as this is more a broader index.
Still you can gleam very important information from the different categories within the report. The production component is related to industrial production. New orders can give clues to Durable Goods Orders. The employment reading can show up in factory jobs created in the non-farm payroll report. Prices filter into the producer price index. And export orders can help give a sense of how strong exports will be in the trade report, and the same for import orders and imports.
Importance:
The ISM Manufacturing index has an important impact on financial markets as its timely and gives info on a major sector of the US economy. The manufacturing sector totals about 13% of US GDP. A stronger manufacturing report means that companies are selling more goods, and with higher earnings for companies, that is good for the stock market and for the US economy, and the global economy as well. Bond markets will rally (yields will fall) when the ISM manufacturing index is weaker than expected. Bonds would fall (yields would rise) if the report was better than expected. That is because a weaker (stronger) manufacturing sector usually means lower (higher) interest rates. A weaker economy is associated with bond prices rising (and yields falling) which would more as a result of a weaker ISM manufacturing report.
The US Dollar (USD), being the world’s main reserve currency can respond differently to the release, but all things held equal, a good ISM Manufacturing report would strengthen the USD as it bolsters the case that the US economy is growing. That would increase projections for growth and likely inflation, which would lead to the prospect of higher interest rates, and that get’s priced into bond markets as bonds are sold off. When this happens yields rise, which makes assets in the US more attractive, inviting foreigners to seek US assets. When they buy these US assets, for instance US Treasuries, they need to convert their money to USD to buy them. That causes demand for USD to increase, thereby increasing the price of USD.
