Though many of us have heard of the unemployment rate, few actually know what it is, what it means, and why it’s important to forex and currency traders. For a trader, the unemployment rate is incredibly important, as it—in its own way—reveals something about the current state of a nation’s economy. The following looks at how the unemployment rate can impact currency prices, and gives three examples of when that will likely be the case.
What Is the Unemployment Rate?Basically, the unemployment rate is the percentage of people without a job in a country’s workforce. These people are still willing and able to work at a job, even if they are unable to find employment. It is measured by a ratio of unemployed people who are able and willing, versus the entirety of people in a nation’s workforce. There is an important distinction, however, between unemployed people and people who are not working. Some people might be in school, disabled, or retired, and these people are not considered part of the workforce and are not included in the rate.
Importance of the Unemployment RateThe unemployment rate is known to be a lagging indicator, meaning that it only changes after the economic state of a country has already changed. This could cause market volatility, since it offers clues regarding economic stability, monetary policy, and interest rates in the future. Those who make policies use unemployment statistics to look at which sectors are losing jobs quicker than others. However, it’s important to realize that unemployment rates should be compared on a year-by-year basis to offset the inherent effects of seasonality; monthly comparisons may not correctly indicate the actual trend.
How Unemployment Rates Impact the Forex MarketThe unemployment rate of a nation shouldn't be ignored. As we’ve addressed above, it can be a telling statistic with regards to economic performance. The following are three common examples of what the unemployment rate can mean for currency prices in today’s forex market.
Higher Than Predicted
If the unemployment rate is too high, the government tries to stimulate the depressed economy by creating jobs. In the U.S., the Federal Reserve will lower the federal funds rate, expanding monetary policy. If this should fail to stimulate the economy, then the Federal Government will employ fiscal policy measures, hire people for public works projects, or stimulate demand with unemployment benefits. When the unemployment rate rises—especially if it does so unexpectedly—it negatively impacts the USD, triggering a bearish turn. A recent example of this occurred during the close of 2017; UK unemployment rose 10 basis points to 4.4%, which saw the GBP/EUR dip to 1.3944 and the GBP/USD fall to 1.3918.
Lower Than Predicted
A lower-than-expected unemployment rate typically leads to more workers that earn income and more consumption expenditure. This may cause inflationary pressure, which then causes interest rates to rise. Unemployment at high levels causes lower incomes, a drop in economic activity, and decreased consumption. A drop in unemployment rate, however, is positive (or bullish), as was recently seen in Japan. Earlier in 2018, the unemployment rate in Japan fell to 2.4%. After this news broke, the USD/JPY fell to 105.96, as the JPY jumped in value by 0.22%.
Below the Natural Rate of Unemployment
Unemployment cannot be sustained for long beneath the “natural rate of unemployment,” as this would cause higher inflation and therefore force the Federal Reserve to increase federal funds rates, all in order to moderate growth. The “natural rate of unemployment” has traditionally been estimated at 5.5%, but debate has swirled surrounding the accuracy of this figure in recent times.
The unemployment rate is incredibly important to forex traders, as it will often determine how policy will react to labor market conditions. Monetary policy changes—or even a lack thereof—can always lead to the value of a currency heading either up or down. While it might be deemed a throwaway figure at times, often when there is only a minimal shift in the number, there is no denying that the unemployment level can impact currency prices
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