Non-farm payroll announcements, confirming the employment situation in the USA outside of agriculture, are one of the most traded regular financial announcements worldwide. Alongside GDP, rates increases, and inflation, non-farm payrolls punctuate the rhythm of the markets, with strong or weak numbers causing volume spikes, spikes that can stop out positions and sometimes ruin strategies. In short, it’s best to be careful, as when consensus expectations for the NFP are not met, it can spell turbulence for the markets.
What is the non-farm payroll?
Exactly as the name suggests, non-farm payrolls include the numbers of US employees currently being paid for work outside of the agricultural sector. Agricultural employment is notoriously seasonal, and often irregular, meaning that including farm payrolls would not give an accurate view of overall jobs market health.
At the same time as the headline NFP number, other data is released by the Bureau of Labour Statistics, including average hourly wages and unemployment. This is important for traders using fundamental strategies, as views on the general strength of the US economy will be influenced by many factors beyond the headline number of jobs, and average wages can be a more useful measure than headline growth. Most FX traders, however, just look at the headline number.
Why is it important?
For traders in Australia or elsewhere, it might seem odd that the jobs market in a far-off country is such an important driver of overall FX rates. When we remember that 75% of all FX trades have the US Dollar as one side, it starts to become a bit clearer. USD is the global reserve currency, with every central bank holding large quantities, and it is critical to international trade. Many countries operating internationally, even between countries where neither uses to USD, will often use dollars for international payments. Accordingly, economic conditions in the US impact global markets, and even countries that trade relatively little with the US are impacted if their main exchange rate relies on the USD.
How do markets respond to the NFP?
The first Friday of every month, at 08:30 New York time (00:30 in Sydney), the non-farm payroll is released. Markets will have an expectation of the number, and if it exceeds that expectation, traders assume that the US economy is stronger than expected, and there is upward pressure on the USD.
Conversely, when the number disappoints, traders rotate out of the USD and into other currencies, depressing the exchange rate. Volume normally spikes immediately after the announcement, and the market is often volatile. Even when the number is mildly positive and in line with expectations, there will often be a flurry of new deals causing a spike in volume.
The most important thing is the gap between the real number and expectations given by economists. Each bank and brokerage house will have its own analysts, who compare data and read other analyst’s reports to come up with an expected number. Sometimes anecdotal reports from employers will also contribute to the overall picture, and all of this information is used to create a ‘consensus view’ about the number.
This means that even if the number is negative and shows the jobs market pulling back, it doesn’t necessarily mean that the exchange rate will fall, because the drop in jobs may already be priced in. If for two weeks leading up to the number every economist has been warning of a sudden fall, when it arrives, the market will already have priced in this information. Economist’s predictions are often quite accurate, but even small discrepancies result in sudden moves.
Should retail traders care?
Yes and no. Yes, because spikes in volatility can stop out positions, especially if the price swings are large, and so you need to be prepared for this market event. It is unwise to commence a new technical strategy an hour before NFP numbers are released.
For traders in Australia, 00:30 is normally a time when all positions are nicely stopped out and the trader is (hopefully) sound asleep. However, for traders using multi-day positions or longer-term trades, it is important to be careful around regular calendar events such as this.
Traders working with fundamental strategies will, depending on the exact strategy they use, need to access economic data promptly and use it to guide their positions. The NFP is important both if your strategy involves trading jobs data, or other related data such as incomes. A strong economy requires people in that country to have access to well-paying jobs, so non-farm payrolls are a useful overall economic indicator.
However, it must be said that for a large portion of traders the only thing they need to do with economic announcements is avoid trading round them. Let’s say you are using a technical strategy where you swing trade based on oscillators, checking for trade opportunities that fit the broader trend. So long as you stop out all of your positions at the end of the day, you probably do not have a longer term fundamental view. Even if you do, and you trend a long uptrend that assumes dollar strength, the non-farm payroll alone may not be enough to reverse that, so you don’t need to abandon your strategy. For traders using purely technical strategies, with no fundamental view whatsoever, the NFP number is simply a volatility spike to be careful of.
Mixing technical and fundamental strategies is often the most coherent way to trade forex, so it is advisable to have at least some interest in fundamental factors. That said, many FX traders use only charts, and do not need to pay such close attention to the NFP number. If you are using a mixed strategy, think about how a non-farm payroll shock might impact your strategy: traders using tight stops may seem them triggered, which can be double frustrating if the number goes on to recover shortly afterwards. Although sudden price jumps can leap past stops, meaning your trade is stopped out at a worse rate, this is unlikely except in exceptional circumstances.
Fundamental traders
Fundamental traders need to be able to revise their views when new data comes out; imagine you have a strategy of opening long dollar positions because you believe that the US Dollar’s reserve status and economic strength mean it will continue its multi-year rise. One bad NFP number probably isn’t enough to change that view, but a string of successive weak numbers would mean broader trouble in the American economy, and would require you to re-evaluate your strategy.
Fundamental traders must be careful not to slip over into news based trading, as this is widely agreed to be an inferior strategy. News based trading involves taking positions during volatility spikes following news or economic data, where you either trade with the market reaction, or make a contrarian trade against it in the opposite direction. In the first you aim to be one of the early movers in the new trend, in the second you hope to profit on the well-known tendency for the markets to (at least initially) overreact to news. These trades require speed and a great deal of confidence, and are not recommended for most retail investors.
How Rakuten can help
The non-farm payroll is both a risk and an opportunity for forex traders. If you understand the number, how it impacts markets and volatility, and want to practice on live market data, why not open a free demo account and start trading today without risking any of your capital?