The nonfarm payroll (NFP) number is a key economic indicator for the US economy. It represents the number of jobs added in the previous month.
It is the most-watched economic indicator in the US by public consumers, politicians, and traders all around the world.
This is why the nonfarm payroll number generally causes large movements in the financial markets, especially in the Forex market. The US-Nonfarm Payroll number is released on the first Friday of every month. Here’s a link to get the data from the Federal Reserve Bank of St. Louis.
In this article, I will show you why the nonfarm payroll (NFP) number is so important and how you can trade it.
The Employment Situation Report (ESR)
The Employment Situation Report (ESR) has various numbers that can give us clues to whether the economic conditions predicted by the leading indicators 6 to 12 months earlier are starting to show in the economy.
This report has the following figures:
- The Unemployment Rate,
- Total Nonfarm Payrolls,
- Private Sector Employment,
- Government Sector Employment,
The NFP number is part of the ESR and it tells us how many jobs were added in the US economy in the previous month, excluding the following areas:
- General Government Employees,
- Private Household Employees,
- Employees of Non-Profit Organizations,
- Farm Employees (seasonal jobs).
It is made up of jobs that have been added in the last month in the Private and Government Sectors.
Why is the Nonfarm Payroll number important?
As I said, it tells us whether the economic conditions predicted by the leading indicators are starting to take effect on the economy or not.
However, it is also important because it is one of the most watched and talked about numbers in the US by the general consumers, the politicians, and traders.
The NFP data can have a direct affect on Consumer Sentiment. When the numbers are good, consumers are prone to spend more as they feel good about the economy. But when the numbers are bad, they switch from spending to saving as they fear the economy will slow down in the near future.
For Government and Politicians
The nonfarm payrolls numbers can have a direct affect on government policies.
When the economy is doing good companies are hiring and jobs are created. This stimulates the economy and consumers are spending more instead of saving. The government and central bank are watching closely the economy. If they see inflation rising, they increase the interest rates to cool down the economy.
When the economy is not doing good and the unemployment rate increases, the government and central bank intervene by lowering the interest rates. They lower the rates to encourage companies and businesses to borrow money to stimulate the economy.
Most of the retail traders focus too much on the NFP numbers as their main leading to trade the Forex market. They also use it to evaluate the current state of the economy.
Misconception around the Nonfarm Payroll number
Many retail traders consider the NFP number as their main indicator to generate trading ideas in the Forex market. This is one of the most amateur and dangerous mistakes. Relying on it simply means the trader is either gambling or missing the point.
By definition, a coincident indicator simply gives traders an idea about the current state of the economy as predicted by the leading indicators months ago. While retail traders focus on the NFP number as a trading opportunity, professionals use it as a confirmation indicator. The market has already received weekly jobless claims numbers. By the time the NFP number is reported, there should be no surprises and more often than not there isn’t.
Professional traders use the leading indicators, such as the ISM Manufacturing PMI and the NMI data to gauge whether the economy is going to expand or contract.
Therefore, predicting future employment situation is made easy as they predict either an increase or decrease of businesses hiring people during the next 3 to 6 months. They also keep track of weekly jobless claims reports to monitor the economy.
For example, if economists forecasted that NFP this month will come in at 150k jobs added in the US economy and the number beats the estimates and is reported at 200k jobs added, this doesn’t mean buy or sell EUR/USD.
Professional traders will already know that the employment situation is set to improve in the employment components of the ISM and NMI not least in the previous month with lowering weekly jobless claims.
The vast majority of times the NFP number will be priced into the market as in the market will have already forecasted 200k adds and economists simply haven’t updated their estimates.
How does the NFP data affect Forex?
The Federal Reserve is monitoring the economy through the employment situation. This is an important indicator to help policymakers decide whether to stimulate or slow down the economy.
Let’s say that we have a higher unemployment rate, the policymakers will take actions to stimulate the economy by lowering the interest rates to increase economic output and increase employment. This will impact the demand of the US dollar as investors are attracted by high yielding currencies.
Which currency pairs are most affected by NFP?
The nonfarm payrolls number is an indicator of the US employment situation, so the majority of FX pairs that include the US Dollar (EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF and others) are affected by the number release.
Other forex pairs also display an increase in volatility following the NFP releases. Traders must be aware of this as well because they may get stopped out. The chart below shows the CAD/JPY during the NFP number release. As you can see on the chart, the data release increases the volatility throughout all currency pairs (majors and crosses), which could easily hit your stop losses.
How to trade the NonFarm Payrolls (NFP) number
The most effective trading strategy is to use the NFP numbers as a means of determining or confirming the long-term trend in the forex market. Basically what you can do is using the NFP data to confirm the current trend; either bullish or bearish and spot early signs of potential reversals in the market.
The strategy consists of constructing a 12-month average of NFP numbers. Then you can plot both the NFP 12-month averages and the pair you want to trade to identify the current market trend.
Here’s an example where we plotted the NFP 12-month average with USDJPY:
As you can see, the NFP 12-month average gives us an early signal to identify market reversals. Between July 1992 and January 1994, the NFP moved higher but the USJDPY was still going down until January 1995. From there, the market changed direction to the upside. The same thing happened again between October 2009 and January 2012.
Also, when the NFP 12-month average was flattening out, we noticed that USDJPY was moving sideways.
As you can see, the nonfarm payrolls numbers can be used to spot early signs of reversals in the market. This can give us sufficient time to plan our trades months ahead.
As one of the most-watched economic indicator of the month, currency pairs typically witness high volatility around the time of data release.
What retail traders don’t know about the nonfarm payroll number is that professional traders take advantage of the high liquidity injected into the market to close their positions. The more retail traders trying to profit from high volatility, the more liquid is the market.