We’re all familiar with the term “unemployment”. We’ve all either been out of work, know someone who has been out of work, or are familiar with the states of the economy that lead to high or low rates of employment. And we also know that the unemployment rate simply refers to the percentage of work-eligible adults in a country that cannot find employment.
But for forex traders, the term takes on increased significance as it is one of the major drivers of fluctuation in exchange rates, and reveals critical factors at play in the state of a nation’s economy.
More About Unemployment Rate Figures
The unemployment rate is said to be a lagging indicator – this means that changes to the rate of employment only happen as a result of the economy itself undergoing significant changes. Unemployment data reflects the underlying economy, so we can usually define it as a “symptom” or reflection of a healthy or suffering economy, rather than a direct cause of those conditions.
After its every release, the unemployment rate can cause market volatility since the underlying numbers are suggestive of economic stability, monetary policy, and are likely to influence the interest rates of a country’s central bank.
Unemployment Rate as an Economic Indicator
As we’ve mentioned, the performance of the labour market is based on underlying economic conditions and business/investor confidence. It’s a figure that’s closely followed by the government and central banks as it helps them understand how changes in the economic conditions are affecting not only people’s lives, but the overall business environment. As such, the figures are frequently used to prepare and adjust economic policy in every country in the world.
High Unemployment Rate
This means a relatively significant portion of the population is without gainful employment, and therefore has no stable income. This tends to negatively impact the currency of the affected country – for example, a high unemployment rate in the UK would be expected to hurt the short-term prospects of the pound (GBP).
The spending tendencies of the unemployed population is naturally limited, and their withdrawal for the larger economy shrinks overall demand.
When the unemployment rate remains high for too long, it can start a cascade of economic slowdown. As demand in the economy shrinks, businesses receive less revenue, and usually resort to laying off more employees in order to rebalance the books. A recent example of this occurred during the close of 2019; 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.
A low rate of unemployment would mean that citizens are enjoying financial security. They can participate in the “consumption economy” beyond the purchase of basic goods and services, thus creating demand for consumer products in the market and boosting business.
As a result, this creates increasing demand and adds value to the available goods on the market, with GDP increasing as a result. Healthy GDP figures are highly correlated with the appreciation of a country’s currency. In this way, a drop in employment rate is seen to be positive (or bullish) and is expected to make the currency rise in value, as was recently seen in Japan. In 2019, the unemployment rate in Japan fell to 2.4%. After this news broke, the USD/JPY fell as the JPY jumped in value by 0.22%.
Optimum or Natural Employment Rate
A sustained period of low unemployment can also be considered disadvantageous. As demand increases faster than supply, it can cause inflation (price of goods and services rise). Employees will demand higher wages to keep up with rising prices, and businesses will need to spend more on payroll and less on growth strategies, which can cause the economy to stagnate.
That’s why economists use the term “optimum” unemployment, sometimes referred to as the “natural rate of employment”. For most economies, it usually falls between the 3.5% and 4.5% percent mark, but debate has swirled about the accuracy of that range in recent times. The central banks will often set these targets.
If the unemployment rate is far higher or lower than the country’s target, this can cause a lot of volatility in the currency exchange rate of the affected country.
In order to meet employment targets within a narrow range, there are certain actions that central banks can take (yes, it is possible that central banks can intervene to increase unemployment). If unemployment is too high, the central bank can cut the interest rates to cheapen bank loans for businesses and encourage them to employ more people. Similarly, an unemployment rate that’s too low can be “amended” through an interest rate hike by the central bank. The market demand would shrink, more people would become laid off, and local prices would drop, thereby reducing the demand for higher wages.
The initial jobless claims and unemployment rates are incredibly crucial to forex traders as it is very efficient in indicating how governments will react to labour market conditions. Monetary policy changes can always lead to the value of a currency rising or falling. Though it can often be seen as a throwaway number in certain circumstances, such as when an economy is stable, often when there is even a small shift in the number, there is no denying that the unemployment rate can heavily impact foreign exchange rates.
The increased volatility makes the unemployment figures one of the most traded data releases in the calendar. Figures out of the US, UK, Australia, New Zealand and the Eurozone are closely monitored for how unexpected figures might drive currency rates one way or another.
If you’re trading the unemployment figures, or any other data release, you’ll want to be sure you’re trading with a regulated, highly reputable broker that you can trust. At TIOmarkets, we don’t only adhere to some of the strictest financial oversight in the world, we also offer our traders unique risk management tools to help you stay in the green and out of the danger zone. Register for an account today to take advantage.
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