What are non-farm payrolls and why do they matter?

What are non-farm payrolls and why do they matter?

You’ve probably caught wind of monthly jobs or employment reports in the financial news and heard terms like “non-farm payrolls” and “NFPs” thrown around. But what do these mysterious figures mean and why do Wall Street traders eagerly await them every month?

In this article, we will try to demystify the Department of Labour’s closely watched data release. You’ll learn exactly what the payroll report reveals, why it causes such market turbulence, and what it means for traders.

What are nonfarm payrolls?

The non-farm payroll report, compiled by the Bureau of Labour Statistics (BLS), tallies month-to-month changes in the number of paid workers across the U.S. economy. It’s a timely and exhaustive investigation into nationwide employment trends.

Farm jobs are excluded due to seasonal variations that would distort comparisons. A few other niche categories like military personnel are also omitted. However, the monthly headline figure still captures over 80% of American jobs.

In addition to the total number of jobs added or lost in a month, the report also includes key details like:

• Average hourly wages
• Weekly hours worked
• Labour force participation rate
• Unemployment rate

Why do payroll numbers move markets?

On the first Friday morning of most months when the BLS data lands at 8:30 am US Eastern time, you’ll likely see financial markets swing sharply in seconds. But why?

First, the payroll figures provide vital economic information for investors. Consumer spending powers over two-thirds of U.S. Gross Domestic Product (GDP). When new jobs abound and unemployment remains low, households ramp up purchases confidently. Corporate profits and equity indices climb in response.

Conversely, anaemic job creation or sudden mass layoffs tend to precede an economic decline as anxious households curb their spending.

Secondly, the Fed watches unemployment and wages trends closely to gauge the economy’s trajectory and capacity. The Fed holds a dual mandate to promote maximum employment while keeping inflation at a modest 2% target.

If the job market overheats with bubbly wage growth, the Fed may accelerate interest rate hikes to restrain price increases. Weak payroll growth may prod rate cuts to spur more hiring and output. So, investors instantly recalibrate rate hike expectations after each report based on the signals.

Payroll surprises = market surprises

On their own, the absolute NFP job additions or losses each month rarely roil markets much. What matters most to markets is the degree to which the figures deviate from the expert consensus forecasts of Wall Street economists. Markets despise inaccurate estimates in either direction.

For example, expect trouble if payrolls rise by just 50,000 jobs when 250,000 was projected. That signals an abruptly slowing economy. Conversely, investor euphoria over a shock 500,000 job month may quickly sour if such unsustainable growth forces quicker Fed rate hikes down the road.

The immediate aftershocks

Traders tend to expect volatility in the first few minutes after NFP numbers are announced. Currency pairs like EUR/USD and USD/JPY could whip back and forth. Major stock indices and bond yields may see jagged swings as algorithmic trading systems issue triggered orders while human traders hesitate.

Such pronounced interim moves mostly represent speculative positions rather than reasoned reactions. Directional shifts often partially or fully reverse within hours or days once dust settles.

Wage growth impacts

While the overall payroll changes make the big headlines monthly, currency traders zero in on the wage inflation component. Accelerating hourly earnings can indicate Fed policy tightening even if job growth slows.

Rising wages also eat into corporate profit margins. Companies struggle to pass on higher labour costs to customers amid stiff competition. This dynamic can affect equity valuations.

How to trade payroll reports

When payrolls hit, even seasoned traders get rattled when charts go from green to red in seconds. It’s imperative to have a trading plan before you enter the market after non-farm payrolls.

Before the non-farm payroll announcement:

• Set stop-loss orders farther from current prices to avoid premature triggers.
• Close out leveraged positions to sidestep margin calls.

Immediately after release:

• Give the markets a few minutes to settle before taking any action.
• Ensure your risk management strategies are firmly in place.

Post-release analysis:

• Weigh wage figures more than job totals for Fed policy clues.
• Compare reports over 3-6 months to see job/wage trends.
• Watch bond yields and inflation expectations more than stocks alone.

While traders ride the monthly payroll rollercoaster, most investors are ultimately focused on the long-range outlook for Fed policy, corporate earnings, economic growth, and currency values. Try not to get overly distracted by the short-term noise in anticipation of and in response to each headline jobs figure.

Use the payroll print as an additional data point while maintaining perspective on the full risk picture spanning geopolitics, corporate profits, commodities, housing indicators, and inflation. The US jobs data provides just one helpful mosaic piece for broader investment strategy.