The 2021 FX price action brought a risk-on trading environment. We may say that the price action for the two months of the year came as no surprise. After all, all investment houses predicted in December last year that the dollar will decline and stocks have more room to the upside.
They were right, as a risk-on environment means a higher euro, British pound, Australian dollar, Canadian dollar, oil, stocks, and a lower US dollar. The only pairs that act differently are the commodity pairs and the USDJPY that follows stocks higher. Although the USDJPY correlation with the equity markets changed in the last years, the pair did act in 2021 as it was supposed to act in a risk-on environment.
However, it all changed yesterday. With only one trading day left in the month, some sharp reversals appeared on the FX dashboard. As always, the downside is more aggressive than the upside due to the panic effect.
For the rest of the quarter, the most interesting price action should be in the AUDUSD, EURUSD, and the USDJPY currency pairs.
1. AUDUSD – Rising Wedge Broke Lower on Divergent Momentum
Up until yesterday, the AUDUSD pair led the risk-on environment for the two months of the year. It squeezed all the way above 0.80, and it remains one of the strongest performers during the pandemic.
The reasons are obvious if we look at how commodities reacted to the monetary easing policies around the world. Because Australia is a major exporter of mineral resources and other commodities, the rise in commodities triggered a rally in the Australian dollar as well. The US dollar was the obvious victim, as the world’s reserve currency declined sharply since the Fed opened the swap lines in April last year.
Despite the rally in the two months of the year, yesterday’s price action signals a potential reversal. The pair formed a rising wedge on its way up to 0.80 and reversed sharply. The move lower already broke the rising trendline that was supposed to act as support, triggering a run for the measured move.
The price action following a rising wedge typically retraces the minimum half of the distance the wedge traveled. Sometimes, it retraces the entire wedge. Therefore, one should not disregard a move back to 0.77 or even 0.75 in the future, especially if the selloff saw yesterday continues.
Momentum does not help the Aussie pair either. The price action diverged, and the last higher high above 0.80 lacked momentum – another reason to turn bearish on the AUDUSD pair.
2. EURUSD – Will Dynamic Support Hold Again?
The EURUSD is on a tear higher ever since the Fed opened the USD swap lines back in April last year. As the chart above shows, the pair remains in a bullish trend, despite the move lower in January. In fact, we may say that the series of higher highs and higher lows remained intact so far.
However, the period ahead looks interesting. Should the EURUSD fail to make a new higher high, the market participants will focus on pushing back towards the 1.20. The round number acts as a huge, pivotal level, considering that the market took a few months consolidating below before breaking higher.
The ECB still has a hard time dealing with the EURUSD exchange rate at such elevated levels, but so far in the trading year it did not have much to do to stop it. Judging by the move higher in the US yields, it may get unexpected help from the United States, as the dollar shows signs of life.
At this point, the technical picture is unaltered. The EURUSD reacted at dynamic support twice. While other dollar pairs, such as the AUDUSD or the GBPUSD made new highs in February, the EURUSD failed to do so. This shows weakness for the rest of the quarter and the focus shifts on the series of higher lows.
3. USDJPY – Key Driver in the Risk-On Move
The two months of the trading year were dominated by a risk-on move. Risk-on means the dollar is taking a beat literally against any other major currency with one exception – the USDJPY. At the same time, the US stocks rally.
What is interesting about this move is the a true risk-on environment has not been in place for years now. In the aftermath of the Great Financial Crisis of 2008-2009, central banks intervened with unconventional monetary policies of various types. As such, the markets were distorted, and rarely we have seen such tight coordination as in the first two months of the trading year.
Moving ahead, the risk-on may turn into risk-off. Not only the bond yields in the United States are rising, but also the ones in Japan, albeit not to the same extent. The differential between the two will be key in positioning for the next move in the USDJPY pair.
Judging by the technical picture, the USDJPY is in a rising trend, and it reacted every time it reached the upper edge of the channel. So far it found bids on every dip, at dynamic support.
Traders should be prepared for anything in the month ahead. We may say that the USDJPY is the wild card moving ahead as it holds the key to the risk-on/risk-off environment. Should we see a true risk-off, the USDJPY may decline together with the overall market. To spot that moment, traders should focus on the lower edge of the rising channel.