The Federal Reserve or the Fed is the largest central bank in the world. And, the most important one.
Firstly, it sets the monetary policy for the world’s reserve currency. The U.S. Dollar is the preferred way for nations to keep their foreign reserves, and the dollar is responsible for over eighty percent of the daily FX transactions.
Secondly, it sets the interest rate for a currency that belongs to the largest economy in the world. Hence, when the Fed changes the rates on the U.S. Dollar, it effectively tells the world about the shape of the United States economy.
Like any central bank, the Fed’s mandate revolves around inflation and its evolution. As it goes with central banks in the capitalistic markets, the Fed targets inflation around the two percent level.
However, while other central banks, like the ECB (European Central Bank) or BOJ (Bank of Japan), target only inflation, the Fed considers jobs data before setting the interest rate level for the dollar. More precisely, the Fed’s vows to create jobs too.
Therefore, setting the monetary policy for the United States economy is a balancing act between created enough jobs and bringing inflation to target.
Because of everything explained so far, the job data out of the United States is crucial for Forex traders, as the dollar is the pillar of the international financial markets.
Non-Farm Payrolls (NFP)
The major jobs-related economic release is the NFP. Released every first Friday of the month, it is the decisive indicator showing the state of the American labor market.
Traders try for the entire month’s course to guess what the NFP will show. The idea is to use the data to position for the NFP and the next Fed interest rate decision or monetary policy change.
NFP is traded heavily by the automated trading industry and by the HFT (High-Frequency Trading) industry too. Namely, programmers instruct computers to buy or sell as quickly as possible the U.S. Dollar based on how the actual release compares with the forecast value.
As a rule of thumb, the higher the NFP number, the better for the dollar. Therefore, those that have a clue into what the NFP may show have a competitive advantage and position themselves ahead of the release. The idea, of course, is to news trade the NFP and to take advantage of the predictability in the HFT industry.
The following economic data helps traders form an idea of what the NFP data will show:
- ADP or private payrolls – released two days ahead of the NFP, shows the jobs created by the private sector and offer a glimpse into what the NFP may show too.
- Employment component in the ISM Manufacturing and Non-Manufacturing releases.
- Initial jobless claims and continuing claims.
The data listed above is released between two NFP releases, and traders build models to predict the Non-Farm Payrolls. When also considering the previous NFP revisions and possible meteorological phenomena (hurricanes, floods, heavy snowing, etc.), the NFP picture becomes more evident and models built this way have the power to predict it accurately.
This article was written by AMarkets