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Non-farm payrolls: why are they important?

We explain exactly what the non-farm payrolls release is, and why it’s so important for investors.

Federal Reserve building
Source: Bloomberg

'Non-farm payroll' is an umbrella term used to describe the headcount employed at manufacturing, construction and goods companies in the US. As the name suggests, it does not include employment numbers for farm workers, private households or non-profit employees.

It’s seen as a fairly influential statistic, particularly in recent times. Its sustained weakness throughout 2011 made it a key area of focus for investors, and it has since fed strongly into many of the monetary policies of the US Federal Reserve. The market is therefore quite sensitive to the releases. The overall number of jobs added or lost is crucial; an important indicator of the current economic situation.

As with all economic data, the estimate is a key part of the buildup. Economists around the globe look at their crystal balls, or tweak their excel models (the result is usually the same) and attempt to divine what the number will be. The reaction to the number can be magnified depending on whether it is close to, distant from, above, or below the estimated figure.

This is taken a step further by the #NFPGuesses game that runs monthly on Twitter in the run-up to the release, and indeed by our analyst-desk sweepstake where ‘cold hard cash’ (£1) is wagered by each individual on what is basically an uncertain outcome. Just to add in another element, the private ADP payroll is released earlier in the week, and while not a direct correlation or link, it is still an important part of the pre-release analysis for NFPs.

The jobs number is only one aspect of the release, however; there are other pieces of data included which possess even greater importance.

1. What the unemployment rate is as a percentage of the overall workforce

The headline number is the most closely-watched, and it was for a time a key part of the Federal Reserve’s assessment of the US economy. It is important to note that this number doesn’t move in tandem with the NFP number, so for example a big rise in jobs might not necessarily also see a drop in the unemployment rate at the same time.

2. Which sectors the increase or decrease in jobs came from

This can be useful for traders as it gives information on which sectors of the economy are on the up.

3. Average hourly earnings

If the same number of people are employed but are earning more or less money for that work, this basically has the same effect as if people had been added or subtracted from the labour force.

4. Revisions of previous non-farm payrolls releases

This is an important component of the report which can move markets, as traders often re-price growth expectations based on revisions to the previous number – particularly if it is a significant revision.

In terms of market reaction, NFPs generally affect most markets around the globe. However, the most rapid (and possibly substantial) reaction is likely to be seen in US indices (Wall Street, US 500, NASDAQ), the FTSE 100, major currency pairs such as GBP/USD, EUR/USD, USD/JPY, AUD/USD, gold and oil prices.

It’s important to note however that, as a trader, it is often best to sit back and wait for the digestion of the release in the broader market before taking a position. A long-term investor will not pay too much attention to daily market noise. Volatility in markets is generally welcomed by traders, but massive volatility (a regular occurrence following this release) can be detrimental for the leveraged trader.

The use of stop losses is, of course, recommended.

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