Non-Farm Payrolls (colloquially known as NFP) is probably the most significant data report in the financial world. It is a record of the number of jobs added (or lost) in the U.S. economy over the course of the previous month excluding those relating to the private household employees, non-profit organisations or the farming industry (thus, non-farm).
It is a key indicator of the state of the economy as non-farm payroll employment encompasses the goods, construction and manufacturing companies in the U.S. The data is usually released to the general public on the first Friday of every month – this is not always the case, especially with the Christmas and New Year period.
The NFP data is significant because it not only affects U.S. based instruments like the U.S. Dollar (DXY), the ForEx market (EURUSD, GBPUSD, USDJPY), the bond market (2-Year, 5-Year and 10-Year Treasury Notes), commodities (Gold, Crude) and the stock market (Dow Jones, NASDAQ) but also the economies of the countries that trade with the U.S. (China, for example).
What do the numbers actually mean?
Well, to show growth, the number that is released must be higher (that is, more jobs) than the previous release. And a shrinking economy will be highlighted by a lower number. Experts and retail traders try to predict these numbers and some go as far as to take up positions in these instruments in anticipation of a move (hopefully in their favour).
A positive number shows that the economy grew in the previous month and in fact, the dollar rallies on this news. After all, a growing economy leads to a strong currency (albeit momentarily, in the grand scheme of things). Such growth must be sustained, however. Most of the time, the effects of data releases of such magnitude die out in a few hours as investors calm down from the frantic trading of the dollar earlier in the day.
A negative number shows a shrinking economy and investors will shy away from the dollar. An economy that is shrinking will see less spending, less jobs and a weaker currency. It suggests that fewer jobs were created in the past month meaning two things. One, less consumer spending took place (although this is not necessarily true), and two, companies were not expanding!
In essence, increases in jobs means that businesses are hiring (expanding) and the logic is that, the newly employed people have more disposable income to spend on goods and services in those businesses, thus fueling growth. The reverse is generally true for decreases in employment.
In truth, no significance should be placed on the data release. It is merely how well (or badly) the economic was in the previous month. It is no indication of how well the economy is doing now. The only reason it is held in high esteem is that data releases, such as the NFP, cause so much volatility to an otherwise mellow (and sensible) market.
Because the market is made up of humans, and even the most rational of humans will be irrational creatures in groups, it is not necessarily the release that causes the markets to move – the volatility is as a result of the irrational reaction and interpretation of the release!
The terms “better than expected” and “worse than expected” are essential in understanding why the numbers mean less than the market’s interpretation of them. A “better than expected” release is one in which the number was more positive than the market expected. This is key in recessionary times were the economy is shrinking and jobs are being lost. If the market expects -200,000 jobs but the economic data is actually -160,000, the market should rally! But this is also dependent on how far off the prediction is from reality. If the actual data is 20% better, it is accepted as “better than expected”.
A “worse than expected” release is the opposite. It is a release in which the number was more negative than the market expected. Traders will usually sell dollars at this point – in anticipation of a weakening currency.
Note here that I refer to “better” and “worse” than expected, rather than “better” or “worse” than previous. While this is also regarded as important by fundamental traders, your average day trader is only interested in whether the data is better or worse than what the market predicts!
But wait! There’s more…
This should all be taken in context of the economy at the time. Interest rates have been kept low for many years (along with other measures to grow the economy). While there has been talk of raising these rates, in light of a heavily over-inflated dollar and an equally over-inflated stock market (although the Dow and NASDAQ have taken heavy beatings ever since making new highs), no one is quite sure when this will happen.
If there were to be a trend of constant growth in the economy (by way of positive, perhaps better than expected NFP data), it is possible that the Federal Reserve will actually increase their rates. While this hints at a steady economy and a strong currency, it has a more damaging effect if not controlled. Too many jobs will lead to too much spending leading to higher prices for goods and services. This is supply and demand at its finest.
A rate rise will make borrowing more expensive. Consumers will be forced to save rather than spend. They will be deterred from taking loans. Inflation will reduce as a result. Businesses will no longer want to expand as it will be more expensive.
On the other hand, the dollar will get stronger. The dollar will have more purchasing power in the longer-term, as inflation drops. Great news for a consumer nation! Great for the manufacturing nations that trade with them – China* prefer a strong dollar (the U.S. can buy more from them and pay in dollars). Investors will move in to purchase more dollars and invest in the dollar because it has a higher yield.
While any data report is a snapshot of the economy at that time (or the previous month), it is not to be taken at face value. One must understand the overall context. Longer-term traders may not be too bothered by one release, but will be focused on what the trend is and will look to use this as an economic indicator.
For the day trader, it is advised to stay away from trading the news at release. The manic behaviour of the market shortly after a release causes whipsaws and gaps in price that can create unnecessary losses. By identifying levels correctly on a bigger picture time-frame, a day trader can assess whether a news release is likely to affect an open trade. Note that, the market will read into a data release, the way it wants to! It is futile to try to predict how the market will react. It is possible to be in a short position, get a “worse than expected” NFP figure, and still see a move against you! Trade what you see, not what you feel.
Your broker will usually create some form of advert to entice you to trade during the news release. It might read like this;
FRIDAY: NFP RELEASE! 1.30PM GMT. DON’T MISS A TRADE! TAKE A POSITION IN EURUSD, GBPUSD, US30 OR NASDAQ!
Ignore this. Your strategy should tell you when to enter a position – not your broker. The broker is ultimately looking to take your money. Plan you trade. Trade your plan.
*China sells goods to the U.S. who pays in dollars. But this is no good. Chinese workers need to be paid in Yuan. The large hoard of dollars also increases the dollar supply in China’s reserves. This means the dollar loses value and the Yuan grows strong. China needs a weak currency to encourage continued trade with the U.S. To combat this, China uses the dollars to purchase U.S. government bonds (consumer debt). This effectively gets rid of dollars and weakens the Yuan but also means China has loaned money to the U.S. and will collect on that loan (that is how loans work, right?). The dollars are then used by the U.S. to buy more goods and services cheaply. And the cycle continues!
Another way China gets rid of its dollars is in the purchase of gold – mainly from Australia (the dollar is the world’s trade currency).