Nonfarm Payroll (NFP): A monthly assessment of the US jobs market

What do these numbers signal?

Nonfarm payrolls include 80% of the number of workers in the US, and therefore is a good signal on the health of the labor market despite suffering from the usual flaws of a survey. An expanding economy often coincides with a healthy labor market, while a weaker nonfarm payroll report reflects a slowdown in the job market which is taken as a negative for the overall US economy.

Rising job numbers and a declining unemployment rate can mean there are more workers in the economy to spend money on goods and services. If the average workweek numbers trend up, it can indicate production gains, which, in turn, can signal the need for companies to hire more workers or increase wage further.

The trend in the report over the months also tells us how tight are the job markets in the US, and whether the demand for workers is being met by the supply or not. If a steady pace of gains in headline NFP is seen over a few months, it can signal a tight labor market, suggesting demand of workers is outpacing the supply.

Wage data can also be a signal on the tightness of the labor market, as steady increases in wages are consistent with supply falling short of demand. Wages are also seen as a signal on the health of the US consumer. High wage growth is consistent with consumers having a strong purchasing power, but that can also become a negative signal if the economy is overheating and inflation concerns arise leading some to believe that monetary policy could be tightened. Meanwhile, faltering employment or wage numbers can signal that consumer may tighten the purse strings, but it can also signal incoming rate cuts.

The report gives out not just the headline on new jobs added within the economy, but also details changes in unemployment by sector and demographics. This can help us to dive deeper to analyze the health of certain sectors. For example, the services sector collapsed during the pandemic but has shown a strong recovery after the global reopening.

In summary, this data set gives a comprehensive look into the US jobs market, which can be a leading indicator for economic growth and a key input for policymakers. However, the direction may not always be entirely clear, which is what usually leads to a lot of volatility. Just remember that one month’s data can have little information value, and it is always more important to look at trends in the economy and a cumulative set of different data points when making investment decisions.

Market instruments that can react to NFP

The NFP report can potentially create a large market volatility. While this may create profit opportunities for some traders, the erratic price movements also mean that spreads can widen and lead to margin calls. Therefore, it is important to have strict risk management rules in place, such as stop-losses or minimal/no use of leverage, when trading the NFP report. Most commonly used instruments to express a view on the NFP include:

• Indices like NASDAQ (USNAS100.I) or S&P 500 (US500.I)
• USD FX pairs such as EURUSD and USDJPY
• US Treasury Bonds
• Yield-sensitive commodities like Gold and Silver
• Other commodities that are priced in dollar, such as crude oil

Traders should take note that some of the other currency cross pairs beyond the USD pairs may also display an increase in volatility when the NFP releases.

How to trade the NFP?

Momentum trading

This usually means that you trade in the direction of the release. This strategy is mostly suitable when there is a broad-based beat or miss in the various data points of the NFP report compared to consensus.

For instance, if the headline jobs numbers, unemployment rate and wage data, all signal a robust US jobs market, that can be a positive signal on the US economy. But depending on where growth and inflation is in the current cycle, if the market expects that Fed has more ammunition to tighten monetary policy, then that is a positive for US dollar but negative for risk assets and equities.

Fade the data

This strategy is based on trading against the initial market reaction to the release. It usually makes more sense when headline jobs numbers and details are a mismatch. Usually the algos and inexperienced traders will react to the headline print, providing an opportunity to professional traders to fade the move once the initial buying momentum is nearing an end.

For instance, a strong headline print may give an initial boost to the US dollar, but if the details are patchy, professional traders could use the higher prices to short the greenback at a more favourable price.

Another extension of this strategy could be to fade the move on Monday especially if Friday’s reaction was large.