My aim for this newsletter has always been to discuss algorithmic modelling and macroeconomic theory, currently with a focus on the foreign exchange markets, and to attempt to link the two together to create a series of macro trading dashboards, strategies and insights. The purpose of these is not just for the FX trader, but also the economist or simply the enthusiast. My aim is for both myself and my readers to gain a deeper understanding of how the “big dogs” see the markets. Most traditional investment banks rely on fundamental analysis, an understanding of the “bigger picture.” These banks don’t believe in purely technical analysis, because this doesn’t give enough significance to what is expected to drive these markets in the future -> supply and demand. In order to determine which direction we think a currency pair might be headed, we have to consider the pair as two economies essentially opposing each other. We have to evaluate each economy for its strengths and weaknesses and based on this, determine the direction we think a pair is headed.
We evaluate an economy by looking at its attributes, or to use a word that lends itself better to algorithms, its features. A country’s macroeconomic features are the statistics relating to the overall health of its economy, examples including GDP, unemployment data, monetary policy decisions, balance of trade etc. In this article and future ones, I will look at key macroeconomic statistics that we need to be aware of when evaluating an economy.
Non Farm Payrolls, or NFP, measures the employment number in the United States, excluding those in farming. This statistic is published as part of a report on the website of the Bureau of Labor Statistics (BLS) on a monthly basis. On their website, under the Current Employment Statistics section, the BLS provide a breakdown of employment changes across 17 industries when compared to data from 1 month, 3 months, 6 months and 12 months prior. Alongside this are the statements for two key indicators, the Employment statistics and the Average Hourly Earnings. These reports provide, in written format, what is displayed on the corresponding graphs. They highlight each industry and its changes from the previous month and the change in average wages earned across the entire economy.
Why is NFP important to currencies?
Let’s consider this on an economic scale and for just the US in isolation, so assuming for now that the other currency in a pair with the USD remains constant in all economic activity. When the employment in the US rises, the economy also grows. Companies are finding increased demand for their goods and services and they hire employees to help contribute towards the growth of their business. This increased demand also brings with it an influx of USD. For customers purchasing US goods from abroad, they are required to change their home currency into USD before purchasing these goods, hence raising the demand for the Dollar. This rise in demand will lead to a rise in value of the US Dollar, which will then be reflected in the value of currency pairs. This process is essentially reversed for falling employment.
The above theory is obviously assuming that all other factors remain constant, which we know realistically not to be true. When we are looking at a currency pair however, we do need to look at each economy individually and evaluate it on its strengths and weaknesses before we make a final decision as to the expected direction of the pair. NFP is therefore a useful metric to keep in our evaluation of the US economy if we observe a link between the reported data and the following chart performance.
How is NFP Analysed?
If you're looking to trade this release short term, it’s worth remembering that the total NFP is the significant driver within the first 15 - 30 minutes of the report being released. This is because in addition to releasing the entire report, the BLS releases the overall figure as single statement to news outlets and broker and this is the single number that institutions and retail traders use to place their short term trades.
According to Investopedia, an NFP change of 100,000+ jobs is considered a significant result, one that is expected to have a more long term reflection in the market, as opposed to the jolt that we tend to see in the 30 minutes following the NFP announcement. An NFP report showing a fall in employment by 100,000 or more tends to have the opposite effect, leading to a gradual fall in the value of the USD.
The second, and potentially more significant way in which NFP is evaluated is in its comparison with the forecasted value. Prior to the release of the figure, which occurs on the first Friday of every month at 08:30 EST, a forecast figure is released that represents the expected NFP value. Depending on how far above or below the actual value is from this expected figure will determine how sharply the market will initially move. We will see examples of this in the case studies I’m preparing for next week’s article. As you can see from the graphs below, the forecast tends to stay reasonably consistent, with the exception of highly influential external factors, as shown by the effects of the Covid-19 pandemic from early 2020 onwards.
In addition to this, Investing.com will display a table of historical NFP releases, including the forecasted value.
What comes next?
From a theoretical standpoint, NFP appears to be a macroeconomic statistic that we would expect to be a useful tool in evaluating the state of the US economy. We also need to empirically verify this and I will take a deeper look into that in next week’s article. I’ll bring up some case studies from the past few months to see how a currency pair was affected in the short and long term following NFP releases. In particular, we’ll study the amount of time it takes before we expect to see returns had we placed a trade after the release and when the affects might start to wear off. Adding this historical analysis to our economic understanding will be useful when creating expectations of future currency pair movements.
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