When thinking about the direction of a certain currency pair there are a few things that I consider. 1) Interest rate differential, 2) Current market theme, 3) Momentum.
If we look at the charts of some of the major currencies, we can see that there have been some distinct momentum changes this last 18 months as a macro theme and new data come into the market making traders, investors, and central banks reprice the currencies.
When viewing the FX majors from April 2018 until April 2020, the majority of the US dollar major pairs directional biases has been for the US dollar to strengthen. For a long time, the US Fed Rates have been positive and higher than most countries, so the flows into the US dollar could be traders looking for yield through carry trades. A carry trade is one based on borrowing in a low-interest rate currency and converting the borrowed amount into a currency with a higher interest rate. There was also a period of political stability in the USA whereas the likes of the UK had major uncertainty around the Brexit decision and outcome, and where there is uncertainty there are usually outflowing towards stability.
Then we had the coronavirus pandemic and all of the macro themes pivoted towards that and the response from the Central banks, governments, and global populations. As the markets crashed the Fed stepped in and changed their monetary policy to be even more accommodative and injected trillions of dollars into the banking system, and overall weakened the US dollar. For the following 8 months, the theme was for the major forex pairs to rise against the greenback.
The European Central Bank (ECB) has not changed its rate since October 2016, and it remains at 0.00% whereas the Bank of Japan has held its -0.100% rate since January 2016. Since the start of 2021, the EURUSD and USDJPY have dislocated themselves from most of the other major pairs back into the old trend of a strengthening US dollar, going back to the carry trade in rate differentials.
We now have new macro themes of rising inflation expectations and yield curves steepening. There are also coronavirus vaccination differentials between Europe, the UK, and the USA. The vaccination rollouts are having a positive effect, so at some point, I am going to make an assumption that covid-19 becomes less of consideration into monetary themes, in the same way as we do not consider the Flu until we catch it. But if we follow the monetary policy theme, nothing has really changed, and central bankers are following a similar path since April 2020. My hypothesis is based on the unwinding of the 2021 effect on the EURUSD and USDJPY and as trade, I had been interested in shorting the USDJPY and going long the EURUSD. However, that doubles up the short US dollar exposure, so the risk would have to be adjusted by at least half for each trade.
The USDJPY is up at multiyear resistance on the weekly chart and the 109 area is proving to be quite a solid price ceiling. While the EURUSD weekly chart shows the single currency is set on an area of balance from the Autumn of 2020, which is looking like it wants to hold as a decent support.
The EURUSD H1 chart shows the response to the FOMC rate hold decision, as the EURUSD popped 80 pips breaking a near-term price channel and today has come back down to retest an old swing high. There is a chance that traders test the low of the Fed candle but traders who missed out on the algo move last night, have now had a 50% pullback and may see the 1.1940 to 1.1950 zone as a value area if they believe in the weaker USD thesis. The ActivTrader sentiment tool shows retail traders are around 60% bearish of the EURUSD so not overly committed to the downside but enough for a contrarian to get long. I would consider the long EURUSD trade invalid at a break and retest of the rising trend line which originates at the swing low from March 9th, 2021. This would be an indication that the market does not believe there will be no rate hikes pre-2023 as they would have unwound the reaction to the continued dovish Fed policy.
On the USDJPY H1 chart, the bearish FOMC candle was unwound at the London open today, but the highs were firmly rejected, which to me opens up the chance to trade down to the previous swing low of 108.30 and then maybe get an acceleration lower. Having such a tight range at multi-year resistance does give a trader an excellent place to limit risk as if prices close higher than 109.40-109.50 the short USDJPY trade idea is invalidated immediately.