What is NFP and how could 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) markets pays extra attention to the US macroeconomic figures, as they reflect the health of the world’s largest economy. Employment data is particularly relevant due to the Federal Reserve's (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 (USD). On the contrary, fewer-than-expected new jobs tend to hurt the US Dollar.

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, as doing so helps to tame inflation. Higher 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%. Despite having retreated from the highs posted in mid-2022, price pressures remain above desired.

Ahead of the announcement, the US released a couple of relevant reports. On the one hand, the ADP report on private job creation showed the sector added 233,000 new positions in October, more than doubling expectations.

Additionally, Real Gross Domestic Product (GDP) increased at an annual rate of 2.8% in the third quarter, according to the advance estimate released by the US Bureau of Economic Analysis (BEA). Finally, and also according to quarterly estimates, there was a modest uptick in inflationary pressures, according to Personal Consumption Expenditures (PCE) Price Index. The core PCE price index increased 2.2%, slower than the 2.8% rise in the previous quarter but above the 2.1% expected.

The figures were not as encouraging as expected but fell short of being enough to twist the Fed’s hand. The NFP report, however, could do it. 

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 since 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. To tame price pressures, US policymakers kept interest rates high for as long as possible.

Finally, the Fed decided to trim interest rates, delivering a 50 basis points (bps) rate cut in September. The announcement brought relief to financial markets, which now see borrowing costs going further down in the upcoming months. As a result, investors seek high-yielding assets, opposite to the safe-haven US Dollar. 

Investors feared the Fed would deliver more aggressive 50 bps interest rate cuts to rush towards a neutral rate to avoid an economic setback.

What to expect from the October NFP report?

Nevertheless, the September NFP report showed that the US economy created 254,000 new jobs in the month, while the Unemployment Rate was confirmed at 4.1%. The US Dollar initially fell after the news but quickly trimmed losses and posted gains that day, as speculative interest understood the economy is in much better shape than initially feared. Market players now believe the Fed would respond to it by trimming the benchmark interest rate by a smaller 25 basis points (bps) from then on.

For October, economists expect the US economy to have created 113,000 new positions, sharply down from the 254,000 jobs created in September. The Unemployment Rate is foreseen at 4.1%, unchanged from the previous month. 

If that’s the case, financial markets will likely welcome the steady job creation without considering a potential impact on the upcoming Fed’s meeting, taking place on November 6-7.

An NFP report showing fewer jobs than expected could spur concerns about the labor market’s performance. 

Hence, the USD will then fall. 

Finally, a report indicating solid job creation should hint at a more modest 25 bps trim in interest rates.

In this scenario, the USD could take advantage of such figures.

As always regarding macroeconomic data, the divergence between expectations and the actual result will determine the strength of directional movements across the FX board. 

The more significant the deviation, one way or the other, the wider the market reaction. Either extremely upbeat or shocking poor readings will exacerbate the directional movements.