EUR/USD: Trading the Change in U.S. Non-Farm Payrolls

Trading the News: U.S. Non-Farm Payrolls

Why Is This Event Important:

As employment in the world’s largest economy is expected to grow at the fastest pace in nearly three decades, the rebound in the labor market is likely to spark increased volatility in the U.S. dollar as investors weigh the prospects for a sustainable recovery. However, as policy makers maintain a cautious outlook for the nation, with the Federal Reserve reiterating its pledge to keep the interest rate near zero for an “extended period” of time, a dismal payrolls report could drag on the exchange rate as economic outlook deteriorates.

What’s Expected:
Time of release:        06/04/2010 12:30 GMT, 8:30 EST
Primary Pair Impact :    EURUSD
Expected:         533K
Previous:         290K

Will This Be Market Moving (Scenarios):

U.S. non-farm payrolls are forecasted to increase 533K in May following the 290K expansion in the previous month, which would be the biggest rise since September 1983, while the annual rate of unemployment is anticipated to slip to 9.8% after unexpectedly increasing to 9.9% in April. As a the economic recovery gathers pace, FOMC board member Thomas Hoenig argued that the “first step toward a normal policy is to move policy rates off zero,” and went onto say that he would like to see the central bank “raise the funds rate target to 1% by the end of summer” as the outlook for growth and inflation improves.

The Upside

With the economy emerging from the worst recession since the Great Depression, businesses may look to widen their labor force as they increase their rate of production. Therefore, a marked expansion in employment could lead the Federal Reserve to revise its assessment for future growth and see scope to normalize policy over the coming months, which could stoke a rise in interest rate expectations as Atlanta Fed President Dennis Lockhart expects the FOMC to raise interest rates to fight the risks for inflation. At the same time,

The Downside

However, as the 2010 Census Bureau spurs a rise in temporary employment, the private labor market will certainly be the primary area of focus as policy makers aim to encourage a sustainable recovery. The ADP employment report showed payrolls increased 50K during the month amid expected expectations for a 70K rise, and the ongoing weakness in the private sector could lead to a dismal non-farm payrolls report as businesses remain reluctant to expand their staff. As a result, we may see a rise in the jobless rate as discouraged workers return to labor force, which could lead the Fed to support the economy throughout the second-half of the year as the central bank aims to temper the down risks for growth.

How To Trade This Event Risk

Trading the given event risk favors a bullish outlook for the greenback as market participants expect employment to jump higher in May, and price action following the release could set the stage for a long dollar trade as growth prospects improve. Therefore, if non-farm payrolls increase 533K or greater from the previous month, we will need to see a red, five-minute candle following the data to generate a sell entry on two-lots of EUR/USD. Once these conditions are met, we will set the initial stop at the nearby swing high or a reasonable distance after taking market volatility into account, and this risk will establish our first target. The second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its mark in order to preserve our profits.

On the other hand, fears of a protracted recovery paired with the ongoing weakness in private sector consumption may lead businesses to keep a lid on employment, and a dismal payrolls report could weigh on the exchange rate as policy makers maintain a  cautious outlook for the economy. As a result, if employment expands 400K or less from the previous month, we will favor a bearish outlook for the greenback, and will implement the same strategy for a long euro-dollar trade as the short position laid out above, just in reverse.

Impact U.S. Non-Farm Payrolls has had on USD during the previous month

April 2010 U.S. Non-Farm Payrolls

Non-farm payrolls in the world’s largest economy expanded a whopping 290K in April to mark the biggest rise since March 2006, while the annual rate of unemployment jumped to 9.9% from 9.7% in the previous month as discouraged workers returned to the labor force. The breakdown of the report showed private payroll surged 231K to top expectations for a 100K rise, with employment in manufacturing expanding 44K, while average weekly earnings unexpectedly held flat during the same period after contracting 0.1% in March. As the economic recovery gathers pace, the Federal Reserve is likely to hold an improved outlook for future growth and may look to normalize policy further in the second-half of the year as the central bank aims to balance the risks for growth and inflation.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the EUR against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the EUR against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com