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Sorry, Wrong Number
Friday's U.S. employment report showed a devastating loss of 17,000 jobs during the month of January, much worse than the expected gain of 70,000 jobs. Reporters noted that it marked the first monthly loss of jobs since 2003, another gloomy cloud hovering above the U.S. economy. Combined with other recent ominous statistics, such as last Thursday's report that showed 375,000 new unemployment applications, a grim picture begins to emerge. Surely this means that the country is headed for a recession.
Or does it? There is a simple yet serious flaw in the calculation of the U.S. Non Farm Payroll number. Consider this; think about how hard it would be to calculate exactly how many tomatoes were consumed by everyone in your immediate geographic area during the month of January. I'm not talking about estimates, but an actual calculation. You could go door-to-door and keep a running total, monitor local supermarkets and fruit stands, and do everything else you can think of to come up with an accurate total, and still miss the mark by a great deal.
But what if the results were due on the first day of the very next month, literally just hours after the end of January? Wouldn't that make the task nearly impossible? You wouldn't have enough time to ask all of your neighbors how many tomatoes they threw on top of last night's Dagwood sandwich.
Now substitute jobs for tomatoes, and survey the entire United States instead of just your neighborhood. How could you possibly report an accurate measure of job creation for the month of January less than nine hours after the end of the month? The answer is this: you can't. We don't know how many jobs were created or lost during the month of January, because it's impossible to produce an accurate count in the time allotted. Because the U.S. Labor Department insists on issuing the Non Farm Payroll report at or near the beginning of every month, the numbers are rarely accurate and look very different after revisions. In other words, when given more time to calculate the net number of jobs gained or lost, the numbers finally make sense.
Since nobody really trusts the numbers, the market is unsure how to react to them. This creates a great deal of uncertainty, and leads to reactions like this one on February 1. As the report was released, the dollar was crushed as EUR/USD rocketed higher; minutes later, the momentum turned as traders realized that the December Non Farm Payroll number had been revised higher. Last month, the Labor Department reported a paltry gain of 18,000 jobs during December – then on Friday, they changed it to 82,000. Whoops! The Labor Department missed the mark by 64,000 jobs. I'm sure a lot of traders went long on the initial news, and then got slammed by the reaction to the revision. It's for reasons like this that I highly recommend that traders avoid the Non Farm Payroll report (see figure 1).
Figure 1: EUR/USD 5-minute chart after Non Farm Payroll release. Source: Saxo Bank
So why doesn't the Labor Department simply move the release of this report back a few weeks to ensure greater accuracy and a more realistic result? That's a very good question.
G'Day, Mate!
While the U.S., the U.K., and Canada are in rate-cutting mode, with Europe likely to follow, where are the remaining high-yield havens? Australia is starting to look very good, for a number of reasons. First, let's take a look at the long term trend, which shows the Aussie gaining steadily vs. the USD during the past two years (see figure 2).
Figure 2: AUD/USD has gained steadily for the past two years. Source: Saxo Bank
Strictly in terms of interest rate differential, what was once a narrow spread has suddenly become a chasm. In the U.S., the Fed has hastily reduced its benchmark Fed Funds rate from 5.25% down to 3.00%, with more cuts likely to come. Meanwhile, Australia just raised its benchmark interest rate to 7.00%. This means that traders who buy and hold AUD/USD will be able to collect a significant amount of interest, in addition to any gains achieved if the currency pair continues its ascent.
On a technical level, this pair has just broken out above resistance at .9000 (90 cents U.S.). This was a hard fought battle that went on for several months, but now it is safe to say that any shorts initiated below .9000 are now feeling pressure to cover their positions (see figure 3).
Figure 3: AUD/USD breaks out above resistance at .9000. Source: Saxo Bank
On the night of February 4, the Reserve Bank of Australia raised its cash rate to 7.00 and commented that "significant inflationary pressures" remained. This can be taken as a hint from the RBA. Perhaps in March, we'll see another increase, which would make Aussie even more attractive from a long term perspective.
Free Special Event in Washington! Chris Koomey, Scott Trello, and everybody at the brand new Online Trading Academy Washington, DC office would like to invite you to a special Forex seminar and book signing event on February 29. I'll be speaking about the Forex market and answering your questions, and my new book "Forex Patterns and Probabilities" will be available at a special discount price. Who knows, maybe Mitt, Hillary, John, and Barack will show up! I hope to see you there.
Question of the Week
Q) Hi Ed, I've been reading your articles on the Online Trading Academy newsletter and find them extremely helpful. On a previous Q&A, you stated to a reader that deep knowledge of "esoteric math" is not required to trade Forex, but in your own words "it doesn't hurt". If I would like to acquire such knowledge, how should I go about it? Pursue an Economics degree? Read books? What's your suggestion? Thanks in advance for your attention.
Ed Ponsi) Thank you for your question. You really don't need advanced skills in this area to succeed. There was a guy I traded with during my early days on Wall Street who was a tremendous trader, one of the very best in the company. He was not exactly a math whiz, in fact I doubt if he would've made it to college if not for an athletic scholarship. His success had nothing to do with math skills, but with his ability to stick with a plan. As I've stated before, trading is a completely different skill set than other areas of finance.
It's not my place to tell you how to gain skills at math – you may already have more skill at mathematics than I do (I always have at least one calculator on my trading desk). However, there are traders out there who practice a form of financial engineering called quantitative analysis. These so-called "quants" create and use computer models as the basis of their trading. The advanced mathematics they use is beyond the comprehension of most individuals, and the strength of their belief in their systems has led to both fantastic gains and spectacular blowups. One well-known, successful hedge fund built around traders and quants with heavy mathematics and problem solving backgrounds is D. E. Shaw & Company. Probably the most infamous of the quant funds was Long Term Capital Management (LTCM), which boasted two winners of the Nobel Prize in Economics on its board of directors. After four years of successful trading, the heavily leveraged LTCM crashed, necessitating a huge bailout by the Federal Reserve Bank of New York in conjunction with several of the world's largest banks and brokers. This shows that even the best and the brightest mathematicians in the world are not infallible. If LTCM had employed good risk management, they would not be a household name today.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through