What is nonfarm payrolls? How does it affect currency markets? And of course, the most important question:
How can I trade this event effectively?
Let’s find out.
Nonfarm payrolls is an economic indicator which measures how the labor market is doing.
Wait, don’t we also have the unemployment rate?
Yes, we do.
We can also gauge different aspects of the labor market.
The unemployment rate, while useful, it’s too unidirectional.
It only tells you how many people are currently unemployed (but seeking).
The NFP goes further than that.
measures how many new jobs were
added to the economy every month.
A few sectors are left out of the indicator (farm and maid jobs to name a few) due to their generally harder to measure nature (informal jobs).
also measures wages. Thus, each month we know how many jobs were added, and we
also know if these jobs were better (or worse) paid.
Think of it from the point of view of Central Bankers, economists, politicians, and businessmen (and traders too).
You want the economy to grow at a decent pace (around 2% for many developed countries these days).
And you want that growth to occur smoothly (stability of prices. In other words, you want to keep inflation positive, but not too high.
To do this, economists have devised a wonderful model to understand how to do this (and it works!).
Since we’re not giving a class in macroeconomics (and who would care about all that anyways…), all we need to know is the following:
The economy as a whole hinges on three important variables or sectors.
Basically, you can get the hang of how well an economy is doing by paying attention to those three (3) aspects.
What are they?
1. Growth, as determined by real GDP;
2. Inflation (price stability), as shown (best) by the CPI; and
3. Labor Market, as shown (best) by the NFP (in the United States).
But NFP’s wage growth component is also a determinant or measure of inflation.
Thus, NFP gauges 2 out of the 3 most important aspects for the economy of the United States.
Since the United States Dollar (USD) is the single most transacted currency in the world, any strong, unexpected NFP result will translate into powerful FX price moves.
That’s why you see the news go mad with job results the first Friday of every month (when NFP is released).
so now we ask: how can we use this knowledge to make some pips?
As powerful as Nonfarm payrolls is, it’s effect on currency markets will vary greatly.
If you’ve read any other of my economic indicator articles, then you the following fact:
An economic indicator only matters when the Central Bank is paying attention to it.
In this case, since NFP is specific to the United States, the Central Bank is the Federal Reserve (FED).
as it happens, at the time of my typing this, the FED doesn’t care about jobs…
For the moment, the labor market is tight (unemployment close to natural rate), and thus, it is no longer an issue for the FED.
At this moment, the FED is more concerned about inflation picking up, before they continue hiking rates.
As such, the more important aspect of NFP, at this moment, is the wage growth component.
This is because strong wage growth signals inflation to come (more wages, lead to more spending, which leads to price increases from producers -inflation).
Conversely, a low wage component (decreased wages) signals lower, or weak inflation, which doesn’t support the FED’s decision to hike rates.
Now, this scenario won’t always be the same.
But it serves as an example of when NFP can be less effective.
the other hand, had the FED been expectant of labor data, then NFP results
would smash currency prices (either way), depending on which way they went.
If the FED cares about the labor market, a better than expected headline on the Nonfarm payrolls (200K jobs added vs 150K expected) would appreciate the Dollar.
Thus, anticipating such a move, or being close to the action to trade as soon as the numbers come out, you could buy USD and pair it with a weaker currency.
For example, if JPY was weaker that day you could long USD/JPY to make some pips!
On the other hand, if the results were particularly poor, you could short USD.
As an example, if EUR is particularly strong that day, you could long EUR/USD (buy euros while selling dollars).
Hope this was useful.
See you soon,
The Forex Economist
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