What is NFP and how does it affect the Forex market?

NFP is the acronym for the Nonfarm Payrolls report, a compilation of data reflecting the employment situation in the United States (US). It shows the total number of paid workers, excluding those employed by farms, the federal government, private households, and nonprofit organisations.

The headline figure, expressed in thousands, is an estimate of the number of new jobs added (or lost, if negative) in a given month. 

But the report also includes the country’s Unemployment Rate, the Labor Force Participation Rate (or how many people are working or actively seeking a job compared to the total population) and Average Hourly Earnings, a measure of how wages increase or decrease month over month.

Why is NFP important for Forex markets?

The Forex (FX) market pays extra attention to the US macroeconomic figures, as they reflect the health of the world’s largest economy. Employment data is particularly relevant because of the Federal Reserve (Fed) mandate. “The Fed's modern statutory mandate, as described in the 1977 amendment to the Federal Reserve Act, is to promote maximum employment and stable prices. These goals are commonly referred to as the dual mandate,” according to the central bank itself.

Generally speaking, a solid increase in job creation coupled with a low Unemployment Rate is usually seen as positive for the US economy and, hence, the US Dollar. On the contrary, fewer-than-expected new jobs tends to hurt the US Dollar.

The DXY US Dollar Index, which measures the value of the US Dollar against a basket of six other currencies, fell sharply on August 2 within the hour after the NFP release, when the data came in below estimates.

However, nothing is written in stone in the FX market.

Ever since the Coronavirus pandemic, markets’ dynamics have changed. The overextended lockdowns and the subsequent reopenings had an unexpected effect: soaring global inflation. 

As prices increased fast, central banks had no choice but to lift interest rates because by doing so it contributes to tame inflation. This is because high rates make it more difficult to borrow money, reducing the demand for goods and services from households and companies and thus keeping prices at bay. 

Interest rates reached multi-decade peaks in 2022-2023, and economies cooled. But inflation took long to recede. In fact, most major economies are still seeing how prices grow by more than what central bankers would like to.

In the case of the US, the Fed’s goal is for prices to grow at an annual pace of around 2%. Inflation has fallen significantly, but it is still at 2.7%.

But what does employment have to do with the Fed?

Keeping unemployment subdued is also part of the Fed’s mandate, but a strong labor market usually translates into higher inflation. The Fed is in a tough balancing act: controlling inflation can mean more job losses, while a very strong economy can mean higher inflation. 

The Chairman of the Fed, Jerome Powell, has long said the central bank needs a “weaker” labor market, meaning that the economy creates fewer jobs, to trim interest rates. 

The US economy has consistently performed very well after the pandemic, creating plenty of jobs month after month. Even though this seems a desirable situation for the country, the Fed read it as a potential risk to inflation.

That’s why it decided to increase interest rates quickly and later keep them high. 

If the NFP report starts to show fewer job gains, the chances that the Fed lowers interest rates increase. This is because easing interest rates means lower borrowing costs for companies and households, reactivating the economy. 

On August 2, almost all main indicators in the NFP report came in below what economists expected (red), so the market took it as a weak report. After this outcome, investors increasingly thought that the Federal Reserve would cut interest rates aggressively.

What to expect from the August NFP report?

The July NFP report showed that the US economy created 114,000 jobs, well below what economists had expected. This outcome put the US Dollar in a selling spiral as investors rushed to price in an interest rate cut in the Fed’s September meeting. Market players were already anticipating this to happen but speculation mounted the central bank could go with a massive 50 basis points (bps) reduction in interest rates, instead of the more conservative 25 bps cut previously expected. 

Ahead of the release of August employment data, market participants are still unsure about the extent of the upcoming rate cut. Even further, Fed officials enhanced the relevance of employment-related data when they met in July, suggesting inflation is not as concerning as it used to be and that the focus is shifting towards how is the labor market doing. 

That makes the upcoming report a critical one. 

The US economy is expected to have created 160,000 new positions in the month after the tepid add of 114,000 in July. The Unemployment Rate, in the meantime, is foreseen at 4.2%, down from the previous 4.3%. Such an outcome would be understood as a stronger labor market and cool down hopes for a 50 bps rate cut. The 25 bps rate trim will still be on the table, but a more modest reduction could boost the US Dollar.

It could be also that the results diverge from expectations. The more significant the deviation, one way or the other, the wider the market reaction. That means that, for example, if the headline reading results in 150,000, the market would barely react. 

However, a reading of 120,000 or even lower could fuel hopes for a wider rate cut and hit the US Dollar hard. The opposite scenario is also valid, with a reading above 180,000 suggesting the labor market is too strong and may even push odds for a rate cut beyond September, sending the US Dollar sharply up against most major rivals.