What is Non-Farm Payroll and why it Matters in Trading

The meaning of non-farm payroll (NFP) is simply the number of workers that are employed, excluding farm workers and a few other job categories. Every month, the US Bureau of Labour Statistics releases the US non-farm payrolls reports. Typically released on the first Friday of every month, this economic report is watched all over the world as it provides the most in-depth look at the health of the US economy. Much of the attention falls with the headline number of how many non-farm jobs were created each month, but it also provides insight on the strength of the US consumer and other metrics that provide hints on the current trends related to the rate of economic growth and inflation.

One of the biggest drivers in the forex market is the interest rate differential between the currencies of two countries in foreign exchange markets. Since the US dollar is the world’s reserve currency, the effective federal funds rate (EFFR) is critical in determining how attractive the dollar is with investors. If the Fed funds rate is much higher than its major trading partners, this has a large impact on forex rates that could keep the foreign investors piling into the greenback.

The Fed’s dual mandate is to promote the two coequal objectives of maximum employment and price stability. Which means the non-farm payroll report will give the Fed the best assessment of the labor market, which is half their mandate. A strong labor market oftentimes means the economy is performing well and allows the Fed to raise interest rates if inflation is running hot. If the economy is weakening and heading into a recession, negative NFP reports could lead the Fed to consider cutting interest rates.

The non-farm payroll report is an indicator of the health of the US job market and economy, so forex traders who trade currency pairs involving the US Dollar (EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, and others) should watch NFP data releases.

A plethora of economic indicators influence economists’ forecasts for the non-farm payroll change reading.

A couple days before the key Friday release, the ADP employment report will show the aggregated payroll data of over 25 million US employees. Since the US labor force is over 160 million, ADP’s glance of how a portion of the private sector is performing could be helpful in confirming the trend of the labor market. The ISM releases both a manufacturing and services report that has an employment index that also provides additional details on quits, retirements, and hiring ability. The Conference Board’s consumer confidence report also has a labor market component that provides the consumers’ assessment on whether jobs are plentiful or hard to get.

The US Bureau of Labor Statistics also releases the Job Openings and Labor Turnover Survey (JOLTS) report which provides a detailed look every month at how many job positions were available. The JOLTS reading is used to determine if there is a considerable shortage of workers for available positions. The Quits component is used to determine if worker confidence is strong and if people believe they can easily find another job.

This is a large sample of what influences the consensus estimate for the NFP headline, but traders should be aware that there are several other job indicators, high frequency labor market data, and surveys that can provide more insight about the labor market.

Forex traders must remain alert around NFP releases as these can be accompanied by sudden rises in volatility. When volatility increases, so do spreads.

Leading up to the anticipated jobs data, much of Wall Street typically enters into a holding pattern. At 8:30 am EST currency traders often see a violent reaction to the release of the US employment report. Significant forex movements can especially happen if the headline payrolls release is nowhere the consensus range from qualified economists.

The initial reaction is frequently highly volatile as it is driven by the headline jobs number, which is the number of workers in the US excluding farm workers. Many traders avoid trading off the initial NFP release as it oftentimes can trigger whipsaw-trading conditions.

After several minutes, financial markets try to completely digest the entire payroll report, which at times can be complicated. If the payrolls report confirms a major shift in the outlook for the labor market, the dollar could have a large-scale reaction that exceeds the average reaction.

What makes NFP day so important is that it not only tells us how many jobs were lost or created, but it also tells us the latest update with wage pressures which is an important contributing driver for inflation.

If average hourly earnings are trending higher, that could possibly fuel further inflation. If the Fed is fighting inflation, they will try to slow the economy and they will pay close attention to which parts of the economy are weakening due to their rate hiking cycle.The Fed does not want their tightening cycle to only impact low-income households and the non-farm payroll report will give a detailed outlook on which type of manufacturing or service jobs are being gained or lost.

The non-farm payroll report has the potential to signal a turning point for the overall health of the US economy, which will influence Wall Street’s expectations on what the Fed will do with monetary policy.

Forex traders should monitor NFP releases as well as other key economic data releases, such as central bank speeches and interest rate data.