Forex Insider: How to Trade the Monthly U.S. Employment Reports

The Biggest Economy's Biggest Trading Event: Monthly US Employment Reports

What It Is

The US Department of Labor's Non Farm Payroll, Unemployment Rate, and Average Hourly Wage reports, released together on the first Friday of each month, combine to form what is arguably the month's key economic news event for the United States. It is intended to represent the total number of paid workers in the U.S. minus farm employees, government employees, private household employees and employees of nonprofit organizations.

The underlying idea is is to capture changes in the number of workers that contribute to GDP. The US Department of Labor releases it on the first Friday of every month 08:30 EST (the day before if that Friday is a holiday). At the same time, the US also releases monthly reports on the unemployment rate and average hourly earnings.

Why It's So Important

Together these reports consistently cause the largest rate movements of any news announcement in the forex market. This is because about 70% of US GDP is from consumer spending, which ultimately depends on employment conditions and their affects on consumer income.

Thus these reports are arguably the most significant indicator of growth of the largest market in the world. Right or wrong, the market’s interpretation of these reports often causes significant movements in global stock, commodity, and forex markets, and can even reverse prevailing trends for the following week.

How Markets Are Affected

Exactly how this event affects the markets has varied over time. Historically, good news (lower than expected unemployment, higher than expected average wages) caused the USD and other assets that benefit from growth, like stocks, to rise. For the past two years, the USD has generally been bought as a safe haven in times of fear ,and thus moves like other low yielding safe haven assets. It moves up on bad news, and down on good news, the opposite of "risk assets," like stocks, commodities, and higher yielding and commodity based currencies. Thus most of the time, a disappointing report boosts the dollar while stocks and other risk assets fall. At times, a very positive report can even boost both the USD and stocks, for reasons we'll discuss another time.

Given the profit potential of trading the related market movements, many analysts, traders, funds, investors and speculators anticipate the NFP number - and the directional movement it will cause. This means that there can be increased volatility and trading opportunities days before the actual report release, because there are reports that come out in the preceding days that hint at the actual result. These include the employment section of manufacturing and services PMI reports, as well as the ADP non farms payroll report. Thus NFP related volatility can begin early in the week of the actual report.

How To Anticipate It

While we do not recommend attempting to trade the NFP based on one's personal prediction of the results, it is still helpful to form an initial bias about whether it will exceed or fall short of expectations. There are different methods for trying to predict the NFP result using different combinations of leading indicators. Here are some of the more popular:

• ADP Non Farm Payroll Report. Attempts to measure the same thing as the US Government report. Generally accurate in predicting the US NFP direction if not the exact magnitude of the change.The ADP figures have been weaker than the initially reported government number by 117K per month on average over the past 4 months.
• The employment component of the service sector ISM. Over the past 10 years, the index has had a nearly 90% correlation with non farm payrolls.
• The employment component of the Manufacturing sector ISM. Over the past 10 years, the index has had a very strong 87% correlation with non farm payrolls.
• The 4 week moving average of new weekly unemployment claims.
• The direction of continuing claims as shown by the prior 2 reports. That is, did the most recent show greater or fewer continuing claims, and was the rate of increase/decrease greater or less when comparing the prior 3 reports.
• Consumer Confidence as per the Conference Board – a poll of 5000 families about their expectations regarding the upcoming 6 months.
• U. Michigan Consumer Confidence Survey – polls 500 people about their expectations for the next 5 years. Because of this smaller sample and longer time horizon, this report is considered less accurate than the Conference Board's report.
• The level of strike activity. A rising # suggests worse NFP, a falling # suggests a lower NFP.
• Monster.com Employment Index (based on the # of online job ads) rising or falling.
• Challenger, Grey, & Christmas y/y Layoff Report on the number of job cuts announced by employers. Limited short term correlation with overall labor conditions.

With so many different parties watching this report and interpreting it, even when the number comes in line with estimates it can cause large rate swings when the report finally does come out at the end of the week. Here's a way to trade this move without getting knocked out by the irrational volatility it can create.

Trading News Releases

This news release creates a favorable environment for active traders in that it provides a near guarantee of a tradable move following the announcement. As with all aspects of trading, whether we make money on it is not assured.

Watching how the market is reacting can provide us with more consistent results than trying to anticipate the directional movement the event will cause.

Trading news releases can be very profitable, but one needs to stay calm and patient. This is because speculating on the direction of a given currency pair upon the release can be very dangerous. Fortunately, it is possible to wait for the wild rate swings to subside. Then, traders can attempt to capitalize on the real market move after the speculators have been wiped out or have taken profits or losses. The purpose of this is to attempt to capture rational, more sustained movement after the announcement, instead of the irrational volatility that pervades the first few minutes after an announcement.

Strategy Disadvantage

While this strategy can be very profitable, it does have some faults to be aware of. For one, the market may move in one direction aggressively and thus may be beginning to fade by the time you get in. It is also important to note that in high volatility times, rates can reverse quickly. This is why it very important to have a stop in place.

The View from Wednesday: Negative

So far, the indicators suggest a worse than expected report. Just a few easily available indicators thus far ALL point to a worse than expected report.

ADP Non Farm Employment: Change was -245K vs. -200K expected and -277K prior. Over 20% worse than expected, but slightly better than last month's result. This should be seen as negative, but both media and the markets have managed to focus on the positive. As of this writing, one hour after the release, global stocks are down on the news but after the first half hour bouncing back, erasing half the drop.

Overall suggests a weaker report than expected. Again, however, remember that the ADP figure has been weaker than the initial government number by an average of 117K over the last 4 months, meaning this one is still too close to call and could actually come out above expectations.

Online job ads: Down over 100K from last month, suggesting a worse than expected report.

Chicago PMI:Came in at 46.1 (below 50 = contraction) vs. 52.1 forecasted and 50.0 last month, again suggesting a worse than expected report.

The Conference Board's Consumer Confidence Index: Was 53.1 vs. 57.0 forecasted and 54.5 prior, suggesting a worse than forecasted report.

Combined with the already extended rallies in risk assets, the above indicators tentatively suggest a disappointing Friday and pullback in risk assets and currencies.

Beware again, however, that markets have been very resilient and focused on whatever positives there are.

DISCLOSURE: THE AUTHOR HAS LONG POSITIONS IN THE ABOVE MENTIONED INSTRUMENTS.