This is How to Trade the NFP Report

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• What is the NFP report?
• Why is the NFP report so important?
• The flaws of the report
• How to read the NFP figures
• What the NFP means for The FOMC, the Economy, and Inflation
• How to trade the NFP report
• The assets that are most affected by the NFP
• Other labor market indicators
• The Final Analysis

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What is the NFP report?

The headline data point is the non-farm payrolls number. It is a measure of how many net new jobs are added to the U.S. economy each month. Along with the NFP figure are data on unemployment, which sectors are hiring or firing employees, the average number of hours worked, the average hourly earnings, and a few other key metrics of employment.

Two of the lesser watched yet still important metrics are the employment-to-population ratio and the labor-force-participation rate. The employment-to-population ratio is a measure of how many people are working relative to the total population, the labor-force-participation rate is a measure of how many people are working relative to those who could be. In recent years, because the Baby Boomers are retiring, the employment-to-population and labor-force participation rates have seen sharp declines.

Why is the NFP report so important?

The NFP report is so important because it is a reading of the core fundamental conditions that drive the U.S. The United States. is a consumer-driven economy, labor market health and wage gains have a direct impact on consumer health. When more people are working, when wages are rising, when employees are confident, and labor markets are tight the consumer if flush with money. When the consumer is flush with money, it is more comfortable spending on things it needs, services it likes, luxuries it can’t resist, and that fuels the broader economy.

The Report has flaws

It may surprise you to know that the NFP, the most closely watched economic indicator in the market, is also one of the most flawed. To begin with, the NFP is the difference between two estimated figures. The government estimates the number of job losses and the number of job gains subtracts one from the other and gives the NFP. It is far from an exact figure and gets revised not once but twice before it is finalized. This means the first figure you hear is often far from accurate.

Additionally, the margin of error is often larger than the actual number. At any given time, on any given release, the Non-Farm Payrolls figure you see in the headline is affected by such a large margin of error it is near meaningless without context.

Bottom line, the NFP is affected by so many variables, the figures are subject to so many revisions, with such a large margin of error it is unusable on its own.

This is how you read the NFP figures

The best way to read the report is over time. For one, this allows the first estimates to be finalized and revisions to be made. It is far better to track the trend of the Non-Farms Payroll numbers than the numbers themselves. Even more importantly, it is necessary to track the trend of the twelve-month average of job gains. The twelve-month average is the best gauge of labor market trends and can be used to judge the importance of all other data within the report.

Likewise with the unemployment and average hourly wage figures, the next two most important data points within the non-farm payrolls report. The headline figures are subject to revision so tracking them over time is the best approach. If unemployment is tracking lower, or wages are tracking higher, it is a good sign of overall economic health. The problem is that on any given month either of these figures could give a false signal, a market moving signal, and you can’t confirm it until the next report comes out.

What the NFP means for The FOMC, the Economy, and Inflation

FOMC has two mandates that it must work to fulfill; full employment and inflation. With this in mind, it makes sense that the FOMC would pay close attention to the NFP numbers and how they are tracking over time. In this respect, the average hourly wages are as important as the payrolls data. Ironically, the FOMC’s two mandates are often at odds with each other because their relationship is circular, one leads to the other.

Full employment leads to inflation leads to higher interest rates leads to less activity leads to less employment leads to lower inflation leads to lower interest rates leads to more economic activity leads to rising employment leads to full employment and on and on.

The FOMC’s true mission is to balance their mandate, keep economic activity as high as possible without inducing too much inflation. In terms of the NFP, the FOMC will be watching the trajectory of job gains, the number of employed persons relative to the workforce and population, and average hourly earnings. They want to see employment on the rise,  unemployment on the decline, and wages rising but not rising too fast.

The two biggest problems faced by the FOMC, relative to the NFP, is if wages are rising too fast and if wages are shrinking. When wages are rising too fast, the economy is in danger from unsustainable over acceleration which brings the need for higher interest rates into focus. Higher interest rates have a negative effect on the economy by making it more expensive to do business. When it is more expensive to do business there is less expansion, less expansion means less demand for employees and less inflationary pressure in wages.

Falling wages are a sign of an economic recession. Wages fall because there is an overabundance of employees for business to choose from. They are able to pay less for the same job because someone will always be there to take it, no matter how low the pay is. In this environment, the FOMC is faced with the dual problem of slowing activity and slack labor markets, problems that can be fixed with lower interest rates. Lower interest rates make it cheaper to do business and are a motivating factor for economic expansion.

How to trade the NFP report

There are two ways to trade the non-farm payrolls report, these are the long-term trend and the near-term news. By far the most effective way of using the NFP for trading is from the long-term perspective. Basically what you are doing is using the NFP to determine or confirm the trend, changes in trend, and major turning points in the market. If the NFP is trending positively and showing signs of strength ie trending above the 12-month average then the fundamental trend of the market is bullish.

In this case, it is advisable to follow only bullish signals when they are presented on a price chart. Price corrections and pull-backs to support levels are often opportune entry points for longer-term style trades. By longer-term style trades I mean trades you will want to keep open for multiple days, possibly even weeks or months.

The other method of trading the NFP is the short-term news; is the NFP better or worse than expected, or does it confirm or refute market expectations. The problem with this method is that the NFP doesn’t always get the market wound up enough to produce a move and, because of its flaws, rarely produces a figure that is truly market moving.

In practice, the two techniques bare some similarities. In order to capitalize on near-term expectations, you need to have a good understanding of the long-term trends and why today’s NFP is more or less important than any other NFP report. Changes in trend and confirmations of expectation are by far the best signals.

These are the assets that are most affected by the NFP

The non-farm payrolls report is important as an economic indicator and as an inflation gauge so it makes sense that it can affect multiple assets and assets classes. It is important to note that two important data points are the actual NFP figure including revisions and trend, and the hourly wage gains.

The Dollar

The dollar is the most obvious market affected by the NFP. The NFP is a gauge of economic health, it is a gauge of inflation, it is an FOMC influencing figure, it has bearing on interest rates, and it can move the dollar. When the NFP is positive and trending positive, especially the hourly wages, you can expect to see the dollar exhibit bullish behavior. Better than expected data is a possible catalyst depending on the inflation situation.

If underlying core inflation, as read by the PCE price index, is running tame it may not matter if hourly wages are running hot. Ironically, hot wage gains are good for the consumer which is also good for the overall economy. Tradable assets that may see a price move when the NFP is released include the Dollar Index (DXY), USD/EUR, GBP/USD, USD/JPY, USD/CHF, any other USD denominated pair including BTC/USD and other cryptocurrencies.

S&P 500/Indices

the NFP can have an impact on individual stocks and that effect is best seen in the indices. The indices movements are the net gain/loss of the stock market as a whole. If the NFP has buyers buying or sellers selling you will see it in the index charts. A strong NFP number can help confirm trends and pinpoint key turning points in bear markets. Likewise, weak or weakening NFP, especially with slowing wages or wage declines, would help confirm bear markets and changes in bull market conditions.

Gold

The NFP has an impact on gold if only because of its effect on the dollar. In reality, the NFP’s economic impact goes much further. A strong NFP may, in fact, support gold prices if there is a sign of industrial and/or physical demand within the economy. If not, you can expect to see gold move contrary to the dollar in relation to the labor data most times.

Oil/WTI/Brent

The NFP is an economic indicator that can affect oil/energy/gas demand outlook as well. If the NFP is trending strongly it is a sign of underlying economic strength and consumer health. These kinds of conditions typically lead to higher energy use for industry, housing/homes, travel, and work. By itself, the NFP is not a good indicator of oil price direction but it can affect the importance of other data. If global oil supplies are tight, tightening, or demand is high or rising, a strong NFP could help spark a rally or fuel one that is already in place.

Some other labor market indicators you should know

There are a few other important labor market indicators you can watch to help predict labor market trends and the NFP.

• The ADP Report is a private-sector gauge of labor market trends akin to the NFP. The ADP and NFP are frequently out of alignment on their gauge of monthly job gains but tend to track alongside each other over time.
• The Challenger, Gray & Christmas report on planned layoffs gives a read on job cuts and planned hirings over the course of the month.
• The JOLTs report is a read on the number of job openings; when there are more job openings than available workers you can expect to see labor markets tighten.
• The Kansas City Federal Reserve’s Labor Market Conditions Index is a broad gauge of labor market health and useful for pinpointing major changes in labor market trends.

The Non-Farm Payrolls Report; The Final Analysis

The Non-Farm Payroll’s report is without a doubt an important monthly data point. It is also, without doubt, one of the hardest to handicap and trade from. While it does have a near-term effect on the market and price movement its value is in the long-term analysis. The trend of job growth, the trend of wage inflation, and the trend of unemployment is far more important than any single data point on any given month.

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