Chinese PMI very sensitive to underlying economic activity

1
Chinese PMI very sensitive to underlying economic activity
The Federal Reserve has 23 more days worth of data and market developments to analyse
before its policy meeting.
China’s official and (unofficial) Caixin manufacturing data for May will be released
tomorrow and Friday before the usual deluge of monthly economic indicators. Markets tend
to give weight to the early release of PMI data in the world’s second largest economy and
the question is whether this is justified.
Looking at data for the past decade, there was a good correlation up till about 2012
between China’s official manufacturing PMI and exports, imports, industrial output, retail
sales and GDP, with the added advantage of the PMI leading by a couple of months.
However, since then these correlations on the surface appear to have broken down, even if
we use the sub-components of headline PMI.
The main issue is seemingly one of calibration. Since 2012, the official manufacturing PMI
has only fallen marginally in a narrow 49.0-51.7 range while monthly economic indicators
have weakened considerably. If we shorten the time scale, the PMI’s correlations with
monthly data again look reasonable.
Markets need to take into account this increased sensitivity of the PMI data, as small
moves may ultimately be associated with significant changes in underlying economic
activity.
Even so, the official manufacturing PMI has seemingly over-estimated China’s economic
strength in recent months. An alternative view point is that monthly economic indicators
are about to rebound quite sharply.
The unofficial Caxin manufacturing PMI data – which have been more volatile than the
official measure – and the official non-manufacturing PMI have even over longer time-
frames been somewhat better correlated with monthly economic indicators. They too point
to a rebound in economic activity in coming months.
Please see Appendix for complete set of correlation charts

2
PMI data for May are China’s first key release
The US Federal Reserve will hold its next policy meeting in 23 days – arguably one of the key central bank
decisions of the year – and it will have a mountain of data and market developments to gage before it
decides whether to hike rates for only the second time in a decade.
First up this week are China’s official manufacturing and non-manufacturing PMI data for May which the
National Bureau of Statistics of China is due to release tomorrow at 09.00 local time (02.00 London time).
The (unofficial) Caixin measure of China’s manufacturing PMI will be released 45 minutes later1
(see Figure
1). The consensus forecast is for little change in either measure of the manufacturing PMI.
Figure 1: Calendar of Chinese data releases
Source: investing.com, www.olivierdesbarres.co.k
Note: London times
Monthly Purchasing Managers' Index (PMI) data can be informative and timely forward indicators of
economic activity, benefiting from being released before official data such as industrial output, exports,
employment, retail sales and ultimately GDP. For example, there has historically been a reasonably strong
correlation between the global manufacturing PMI and global real GDP growth (see Figure 2), with the
advantage that PMI data are released weeks and sometimes months before country GDP data.
1 Up until June 2015 HSBC sponsored China’s unofficial PMI which is compiled by Markit
Date Forecast Previous 4-year high 4-year low
Official manufacturing PMI (May) 1 June (02:00) 50.0 50.1 53.3 49.0
Official non-manufacturing PMI (May) 1 June (02:00) na 53.5 56.7 52.7
Caixin manufacturing PMI (May) 1 June (02:45) 49.3 49.4 52.3 47.2
Caixin services PMI (May) 3 June (02:45) 52.0 51.8 54.7 50.0
Exports, % year-on-year (May) 8 June (03:30) -2.0 48.3 -25.4
Imports, % year-on-year (May) 8 June (03:30) -10.5 29.6 -20.5
CPI-inflation, % year-on-year (May) 9 June (02:30) 2.3 3.4 0.8
PPI-inflation, % year-on-year (May) 9 June (02:30) -3.4 -0.7 -5.9
Fixed asset investment, % year-on-year (May) 12 June (06:30) 10.5 23.1 6.8
Industrial output, % year-on-year (May) 12 June (06:30) 6.0 10.4 5.4
Retail sales, % year-on-year (May) 12 June (06:30) 10.1 15.2 10.0

3
Figure 2: Global PMI and GDP growth are well
correlated
Figure 3: Correlation between China’s PMI and
GDP growth has seemingly weakened in recent
years
Source: JP Morgan/Markit,IMF
Note: IMF does not publish quarterly global GDP data,
which I therefore estimate from country data using the
IMF’s methodology and weights.
Source: National Bureau of Statistics of China
Correlation of official manufacturing PMI with economic activity has seemingly weakened
Figure 3 suggests that the official Chinese manufacturing PMI was well correlated with real GDP growth
between 2007 and 2010 but that since then the correlation has weakened. Specifically, GDP growth never
rebounded to the levels implied by the PMI data and then slowed faster than implied by the PMI data.
Similarly, the correlation between China’s official manufacturing PMI and monthly measures of economic
activity has seemingly broken down since 2012, including with exports (see Figure 4), imports (see Figure
5), and industrial output (see Figure 6). The correlation between manufacturing PMI and new fixed
investment was never very good (see Figure 7).
The headline manufacturing PMI number is an aggregate of thirteen variables, which may go some way in
explaining the breakdown of its correlation with monthly economic indicators. But the correlation of its sub-
components – such as new orders – with Chinese exports, imports, industrial output and retail sales has
also seemingly weakened in recent years.
Figure 8 shows that the correlation between manufacturing PMI new orders and Chinese export growth
was strong between 2007 and 2012 – including during the great financial crisis which saw both variables
collapse. Moreover, the PMI number had the added advantage of seemingly leading export data by a
couple of months (this makes sense as there are typically contractual lags between exporters noticing a
pick-up in orders and these orders actually translating into hard sales recorded in official statistics). The
picture is similar if we look at new export orders (see Figure 9).
2.0
2.5
3.0
3.5
4.0
48
49
50
51
52
53
54
2012Q4 2013Q4 2014Q4 2015Q4
Global manufacturing PMI, left scale
Global real GDP, % year-on-year
(IMF methodology)
6
7
8
9
10
11
12
13
14
15
16
40
42
44
46
48
50
52
54
56
58
2007-Q2 2009-Q2 2011-Q2 2013-Q2 2015-Q2
Official Chinese manufacturing PMI, left scale
Chinese real GDP, % year-on-year

4
But this correlation has seemingly broken down since 2012, with new orders and new export orders failing
to pick up the collapse in the USD-value of Chinese exports. The correlation between manufacturing PMI
orders in hand and export growth seemingly held up a little better until late 2014 but has also weakened in
the past 18 months (see Figure 10).
Turning to imports, the picture is similar – the correlation between the change in the USD-value of imports
and China’s manufacturing PMI imports seemingly broke down a few years ago (Figure 11), as has the
correlation with the PMI purchasing volume (see Figure 12). Ditto for the correlation between PMI
purchasing volume and retail sales growth (see Figure 13) and for the correlation between PMIs and
industrial output growth (see Figures 14 & 15).
Recalibration shows usefulness of manufacturing PMI
The main issue is seemingly one of calibration. Between 2007 and 2012 official Chinese manufacturing
PMI data moved in large ranges, in tandem with sharp swings in monthly economic indicators. But since
then, the official manufacturing PMI has only seen small moves in a narrow 49.0-51.7 range while monthly
economic indicators have on the whole weakened considerably (see Figure 16).
If we shorten the time scale – which effectively re-calibrates the PMI data – the correlations with exports,
imports, industrial output, retail sales and ultimately GDP growth look reasonable (see Figures 17-21). Put
differently, the sensitivity of the PMI data appears to have increased with ultimately small moves in the PMI
associated with large moves in indicators of economic activity.
Figure 16: Official Chinese manufacturing PMI has
moved incrementally in past four years, Caixin
measure more volatile
Figure 17: Over shorter time frame, recalibrated
manufacturing PMI correlates reasonably well with
export growth…
Source: National Bureau of Statistics of China, Markit Source: National Bureau of Statistics of China, General
Administration of Customs
35
40
45
50
55
60
Mar-07 Mar-09 Mar-11 Mar-13 Mar-15
HSBC/Caixin
Official
China manufacturing PMI
48
49
50
51
52
53
54
-15
-10
-5
0
5
10
15
20
25
Year-on-year % change in 3-month moving
average of $-value of Chinese exports
Chinese manufacturing PMI, two-month lead,
right scale

5
Figure 20: … retail sales growth… Figure 21: …and ultimately Chinese GDP growth
Source: National Bureau of Statistics of China, General
Figure 22 shows the latest PMI and monthly data points relative to their 4-year ranges. For example, the
latest PPI-inflation number (-3.4% year-on-year) was broadly in the middle of its -0.7% to -5.9% range (see
Figure 1) and is thus attributed a score of 48 out of 100 (i.e. it is in the 48th
percentile). The latest
manufacturing PMI number is in the 26th
percentile – broadly in the middle of the other monthly economic
indicators’ percentile positions.
Figure 22: Latest official manufacturing PMI data tally reasonably well with other monthly indicators
Source: National Bureau of Statistics of China, General Administration of Customs, Markit
48
49
50
51
52
53
54
9
10
11
12
13
14
15
average of Chinese real retail sales
right scale
6.5
6.7
6.9
7.1
7.3
7.5
7.7
7.9
8.1
49.0
49.5
50.0
50.5
51.0
51.5
52.0
2012-Q1 2013-Q2 2014-Q3 2015-Q4
Official Chinese manufacturing PMI, left scale
Chinese real GDP, % year-on-year
0
10
20
30
40
50
60
70 Latest data point relative to 4-year range (min = 0, max = 100)

6
Either recent PMI data overstate strength of economic activity or latter is about to rebound
Even so, the official manufacturing PMI data have seemingly over-estimated the strength in economic
activity in recent months. Of course an alternative view point is that monthly economic indicators are about
to rebound quite sharply.
Importantly, the unofficial Caxin manufacturing PMI data – which has been more volatile than the official
measure (see Figure 16) has even over longer time-frames been somewhat better correlated with monthly
economic indicators, including exports (see Figure 23), imports (see Figure 24), industrial output (see
Figure 25) and retail sales (see Figure 26).
Overall, the official manufacturing PMI, and in particular the Caixin measure, still have informational value
as long as one is sensitive to even minute moves in these variables – which carries its own analytical risks.
Figure 23: Caixin manufacturing PMI better
correlated (than official PMI) with exports…
Figure 24: …and with imports…
Source: General Administration of Customs, Markit Source: General Administration of Customs, Markit
Official non-manufacturing PMI better correlated with economic activity
The official non-manufacturing PMI has exhibited more of a downtrend in recent years than the official
manufacturing PMI (see Figure 27). Unsurprisingly, therefore, it has at the margin seemingly been better
correlated (than manufacturing PMI) with economic indicators, particularly exports, even over longer time-
frames (see Figures 28- 30).
46
48
50
52
54
56
58
-30
-20
-10
0
10
20
30
40
50
Caixin manufacturing PMI, right scale
46
48
50
52
54
56
58
-30
-20
-10
0
10
20
30
40
50
60
70
average of $-value of Chinese imports

7
Figure 27: Non-manufacturing PMI has declined a little faster than manufacturing PMI in recent years
The non-manufacturing PMI does not directly capture industrial activity or exports of goods but may well
indirectly reflect the importance of the construction and retail sectors in China as well as the growing
importance of services in the Chinese economy. Perhaps less surprisingly, the non-manufacturing PMI
correlates reasonably well with retail sales (see Figure 31).
Figure 28: Surprisingly official non-manufacturing
PMI correlates well with export growth…
Figure 29: …and to an extent with import growth…
50
52
54
56
58
60
62
64
-25
-15
-5
5
15
25
35
45
55
Chinese non-manufacturing PMI, two-month
lead, right scale
50
52
54
56
58
60
62
64
-30
-20
-10
0
10
20
30
40
50
60
70
lead, right scale
38
40
42
44
46
48
50
52
54
56
58
60
62
64
38
40
42
44
46
48
50
52
54
56
58
60
62
64
Mar-07 Jan-08 Nov-08 Sep-09 Jul-10 May-11 Mar-12 Jan-13 Nov-13 Sep-14 Jul-15 May-16
Manufacturing PMI Non-manufacturing PMI
Official PMI

8
Figure 30: …and industrial output growth Figure 31: Unsurprisingly, non-manufacturing PMI
correlates well with retail sales growth.
Source: National Bureau of Statistics of China Source: National Bureau of Statistics of China
50
52
54
56
58
60
62
64
4
6
8
10
12
14
16
18
20
Chinese industrial output, year-on-year %
change in 3-month moving average
lead, right scale
52
53
54
55
56
57
9
10
11
12
13
14
15
lead, right scale

9
APPENDIX
Sources: National Bureau of Statistics of China, General Administration of Customs, IMF, Markit
Figure 4: Correlation between China’s
manufacturing PMI and export growth has
seemingly broken down since 2012…
Figure 5: …as has correlation between
manufacturing PMI and Chinese import growth…
Figure 6: …and correlation between
manufacturing PMI and Chinese industrial output
growth
Figure 7: Correlation between manufacturing PMI
and new fixed investment never very good
38
42
46
50
54
58
-25
-15
-5
5
15
25
35
45
55
right scale
38
42
46
50
54
58
-30
-20
-10
0
10
20
30
40
50
60
70
right scale
38
42
46
50
54
58
5
7
9
11
13
15
17
19
21
right scale
38
42
46
50
54
58
5
10
15
20
25
30
35
40
average of CNY-value of new fixed investment
right scale

10
manufacturing PMI new orders and export growth
has seemingly broken down since 2012…
Figure 9: …as has correlation between PMI new
exports orders and Chinese export growth.
manufacturing PMI orders in hand and export
growth has held up a little better
manufacturing PMI imports and import growth has
fared poorly in recent years…
30
35
40
45
50
55
60
65
70
-25
-15
-5
5
15
25
35
45
55
Chinese manufacturing PMI new orders, two-
month lead, right scale
30
35
40
45
50
55
60
65
-25
-15
-5
5
15
25
35
45
55
Chinese manufacturing PMI new export orders,
two-month lead, right scale
35
40
45
50
55
60
-25
-15
-5
5
15
25
35
45
55
Chinese manufacturing PMI orders in hand,
two-month lead, right scale
32
36
40
44
48
52
56
60
-30
-20
-10
0
10
20
30
40
50
60
70
Chinese manufacturing PMI imports, two-month
lead, right scale

11
Figure 12: …as has correlation with PMI
purchasing volume
Figure 13: Correlation between manufacturing PMI
and retail sales also seemingly breaking down
Figure 14: Correlation between PMI new orders
and industrial output growth
Figure 15: Correlation between PMI production
and industrial output growth
32
36
40
44
48
52
56
60
64
68
-30
-20
-10
0
10
20
30
40
50
60
70
Chinese manufacturing PMI purchasing
volume, two-month lead, right scale
36
40
44
48
52
56
60
64
68
8
10
12
14
16
18
20
22
24
Chinese manufacturing PMI purchasing
volume, two-month lead, right scale
30
35
40
45
50
55
60
65
70
4
6
8
10
12
14
16
18
20
Chinese manufacturing PMI new orders, two-
30
35
40
45
50
55
60
65
70
4
6
8
10
12
14
16
18
20
Chinese manufacturing PMI production, two-

12
Figure 18: …import growth… Figure 19: … industrial output growth…
Figure 25: …Industrial output…. Figure 26: …and retail sales
48
49
50
51
52
53
54
-20
-15
-10
-5
0
5
10
15
right scale
48
49
50
51
52
53
54
4
5
6
7
8
9
10
11
12
right scale
46
48
50
52
54
56
58
4
6
8
10
12
14
16
18
20
46
48
50
52
54
56
58
8
10
12
14
16
18
20
22
24

Chinese PMI very sensitive to underlying economic activity

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