Hot Topic: Non-Farm Payrolls & How to Trade Them

Typically released on the first Friday of every month, the non-farm payrolls are widely acknowledged as being the benchmark measure of the current US employment situation. The data is collated by the Bureau of Labor (sic) Statistics - a US government department - and its publication typically delivers significant levels of volatility across several major asset classes. It has to be said that the market reaction can often exceed the significance of the print itself. With that in mind, traders holding open positions across the release, which takes place at 8.30am EST, should always be cautious regarding stops, limits and available margins.

So what moves, and why?

Part 1 - The Dollar

High levels of employment typically point towards inflationary pressures, as employers end up competing for staff and driving wages higher as a result. The last decade or so has seen something of a disconnect here as the advent of the ‘gig’ economy – think Uber drivers or the folk working for Deliveroo - meant many were being counted as employed, but often as a result of very low wages. There does however now appear to be evidence that this situation has been worked through and with average wages starting to rise, the inflation threat is resurfacing.

As such, bumper non-farm payroll numbers could once again be seen as an indicator that the Federal Reserve will need to look at tightening monetary policy. Conversely, weaker numbers classically hinted towards the idea that the economy required more stimulus in the shape of lower interest rates to encourage companies to invest. The natural progression here is that higher employment suggests rising interest rates so the reference currency – in this case the US Dollar – should appreciate.

Part 2 – the Dow (other indices do exist…)

The benchmark US indices can also see some meaningful reactions from payroll data, although this has the potential to be the proverbial double-edged sword. High employment paves the way for high interest rates. This pushes bond yields up and makes investing in equities less attractive, thereby depressing the stock market as a whole. Conversely, low employment raises questions over consumer demand – something which some will say sits at the very heart of the US economy. If people aren’t in work then they’re likely unable to buy new cars, smartphones or houses, in turn depressing company profits and beyond that their valuations. This is where the so-called ‘Goldilocks zone’ kicks in, with the market looking for a happy equilibrium. A number that’s neither too hot nor too cold if an equity market rally is to be maintained.

Part 3 – Gold (or another risk off asset)

The market doesn’t like uncertainty and it’s fair to say that it’s no fan of surprises, either. As such, big deviations away from expectations in the non-farm payrolls can themselves be a trigger for price action. Uncertainty also paves the way for flight to safety, so with this in mind, assets like gold can prove to be attractive investments when the numbers don’t appear to be adding up.

The last decade, which has been defined both by ultra-lax monetary policy and some significant changes in the way the labo(u)r market operates, has at times pushed the traditional rule book of how markets react to the payroll data to one side. However, the economy is playing catch up, interest rates are normalising and the success of the gig economy is now driving wage inflation once more.

So now for the million-dollar question – just what is the best way to try and profit from the NFPs? The potential volatility in the minutes after a payrolls release cannot be understated. Typical movements often include dramatically exaggerated jumps in one direction before a reversion then follows. Constructing a series of short term straddle trades in a bid to exploit these movements may prove profitable.

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