Introduction to the NFP
NFP stands for Non-Farm Payrolls, which refers to a USA data release referring to labour statistics.
NFP is just one of the data releases relating to employment that affects the Forex markets. Labour statistics give an important insight into a country’s economic health, as jobs (and the creation of jobs) are key to a traders’ opinion of the medium to long-term economic outlook for a country.
Employment is the backbone of economic growth – when unemployment levels in a particular country rise, this has an adverse effect on the country’s economic growth. This means that traders will have a dim view of the economic health of the country and will begin to sell its currency, which in turn weakens the currency in relation to others.
Other signs of economic growth are often viewed with a little suspicion by the market if employment figures are not at a healthy level.
Employment figures can also have an impact on interest rates, as higher employment will lead to higher interest rates because of central bank policies aimed at balancing inflation with growth. This is a significant factor for Forex traders, because interest rates are the most important rates when it comes to Forex trading.
For all of these reasons, it is important for traders to keep an eye on employment levels, and one method of doing so is through NFP.
NFP (or Non-Farm Payrolls) is a monthly report researched, recorded and reported by the US Bureau of Labor Statistics on the first Friday of every month. This data release is intended to represent all paid US workers of any business, with the exception of the following:
- Government employees
- Private (household) employees
- Non-profit employees
- Farm employees (hence the name)
The report includes estimates of the average working week and the average (weekly) earnings of all non-farm employees. The data in the report typically accounts for about 80% of all US employees, whose labour produces the GDP (Gross Domestic Product) of the US.
NFP is a very significant employment data set because of its central importance to the movement of the currency market, and the US Dollar in particular.
NFP usually has the greatest impact on the market where there is a discrepancy between the expected data and the actual figures. For example, if the data is higher than expected, the USD will usually rise in value relative to other currencies, because the perceived future strength of the US economy encourages traders to buy USD, which drives up price in accordance with the economic principle of supply and demand. And vice versa, if the data is lower than expected. But more on that later.
However, NFP does have its limitations. Although it is of central importance to traders due to the huge amount of volatility the release has the potential to create, from an economist's standpoint, the number is not the be-all and end-all figure it seems to be.
Although it is a key indicator of the economic situation in the United States, we need to also consider that there are several other key economic indicators that show the health of the US economy, and the NFP release alone is not strong enough to warrant an assessment of the US economy without reference to other data sets as well.
One important data set is the unemployment rate released on the same day as the NFP, and we also have key data in the form of GDP, CPI & Retail Sales. Each of these leading indicators must be assessed when considering the overall health of the economy.
There are also some issues to be considered with the actual NFP report itself:
- First of all, the number is actually backdated and gives a view of how the economy was last month, not how the economy actually is right now. So whilst that data collection might be as good as we can get, it isn't perfect.
- The number can be significantly impacted by certain elements and is open to distortions. The most notable of these is the big impact that periods of very adverse weather conditions can have on the number, causing a very acute change in the number during the period of bad weather. So whilst the health of the economy might generally be very good, a period of extremely bad weather can actually create a very low NFP reading, painting a falsely weak picture of the economy.
- The context of the economy at the time needs to be considered when assessing the broader implications of the reading. We can see how this plays out with reference to the language used concerning the anticipation of the jobs report. Phrases such as "better than expected" and "worse than expected" can take on entirely different meanings in different business cycle conditions. In a highly recessionary environment such as we saw during the global financial crisis, an otherwise very weak number might be seen as "better than expected" simply because it beat the very low expectations at the time.
So whilst the NFP is obviously a key data point for the US economy and is extremely important to market participants, it is important to understand its flaws as well as its strengths. Needless to say, these more complicated fundamental considerations are not essential to trade the NFP: a solid technical strategy is perfectly powerful enough to profit from this risk event.
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