Talking Points:

Yen Gains, Aussie and Kiwi Dollars Fall as Markets Digest Recent Volatility
S&P 500 Futures Hint Correction Likely to Continue Amid Event Risk Lull
Sentiment Trends Look to Fed Chair Yellen’s Testimony for Direction Cues

The sentiment-linked Australian and New Zealand Dollars underperformed while the safe haven Japanese Yen edged higher as S&P 500 stock index futures declined in overnight trade. The move appeared to reflect corrective price action following the dramatic recovery in the benchmark stock index late last week. The US equities gauge – a proxy for market-wise sentiment trends – rallied 2.5 percent over a mere two sessions, producing the strongest back-to-back winning streak in four months.

Looking ahead, a lackluster set of European and US economic data releases offers little by way of directional catalysts. That suggests that corrective price action is likely to carry forward for the time being as investors digest recent volatility and prepare for what is arguably this week’s main event: Congressional testimony from newly-minted Fed Chair Janet Yellen.

Yellen’s remarks may help illuminate the markets’ curious response to last week’s disappointing employment report. The underwhelming 113,000 increase in nonfarm payrolls – a result that fell short of economists’ calls for an 180,000 gain – extended an increasingly deteriorating month-long trend in the performance of US data outcomes relative to expectations.

A string of weaker-than-forecast economic indicators coupled with Fed officials’ vocal opposition to slowing the QE “tapering” cycle might have been expected to weigh against risk appetite. The S&P 500 seems to clearly show that investors had other things in mind however. As it stands, there are two compelling narratives that may help to explain this disconnect.

First, the US unemployment rate fell to 6.6 percent in January, putting it within a hair of the Fed’s 6.5 percent guidance threshold. It is conceivable that markets are hoping that the FOMC’s commitment to reduce QE is a change in the way stimulus is delivered rather than it’s the abandonment, with a downward revision in the target jobless rate being the next policy step.

Alternatively, it may be possible that anti-risk positioning had simply become over-extended. Indeed, speculative positioning in S&P 500 futures registered as its most net-short reading in eight months last week. Having put the week’s biggest sources of event risk – the ECB rate decision and the US jobs report – behind them, traders may have seized on a lull in incoming negative news-flow to book profits.

If Yellen’s testimony alludes to the former scenario, risk-geared assets are likely to continue trending higher. On the other hand, the absence of a palpable dovish shift in the Fed Chair’s rhetoric may rekindle risk-averse dynamics in play since in mid-January.

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