From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
One of the most frustrating questions plaguing investors at the moment is... "How long will this choppy environment last?"
And one question we’re asking internally is… “What is with all these mixed signals!?”
Once the latter clears itself up, we'll have our answer to the former... But not until then.
When the outlook becomes increasingly murky, the best action is to take a step back, let the smoke clear, and weigh each new piece of evidence as it becomes available.
For now, the most important evidence we have is our list of risk-on commodities and equity indexes testing critical levels of interest grows larger by the day.
There seems to be no end in sight. Complicating matters further, we’re actually seeing this kind of price action throughout the risk asset landscape. It's not isolated to a single asset class or region. We're seeing it in Stocks, Bonds, Commodities, and even Currency Markets... and not just in the US, but also abroad.
There are plenty of consolidations taking place at key levels right now. But we aren't seeing any decisive resolutions (yet). And that's where we're going to get our information. Until then, the environment is just a waiting game.
Today, we’re going to dive into the currency markets’ most popular risk-on pair, the Aussie/Yen, and see what it’s telling us about the likely future direction for markets.
Here’s a long-term view of the AUD/JPY chart, zoomed out almost a decade:
AUD/JPY violated a long-term downtrend line last December and has continued to gradually grind higher as it carves out a multi-year bottoming pattern, indicating a change in the primary trend is likely underway.
This bearish-to-bullish trend reversal becomes a lot more real if and when we get a decisive move above those key 2018 highs around 84. Price is knocking on the door of this critical level as we type.
It’s no coincidence that many commodities within the base metals and energy sector also experienced similar upward price movements off of last year’s lows.
In fact, if you overlaid some risk-on commodities with this chart, you’d notice some striking similarities. That’s because these are more than just price charts. These assets also give us valuable information about investor risk appetite. And the Aussie/Yen is right at the top of the list when it comes to the best and most reliable intermarket risk barometers.
Considering the environment we’re in… with risk assets hitting resistance as more and more evidence adds up in favor of the bears… we want to be watching AUD/JPY and other risk gauges for clues.
Let’s pick this forex cross apart. After a swift rally off the 2020 lows, price has been coiling in a bullish continuation pattern and digesting gains for nearly three months.
Here's a closer look at a daily chart:
Not only is price consolidating in a bullish formation, but it’s where it is doing this that matters. Notice how AUD/JPY is chopping around just above our prior target and key risk level at those former highs.
This is typically positive and would suggest a resolution in the direction of the underlying trend.
But there is more going on here. After a strong run-up, this trend appears to be running on empty. This is illustrated by the lackluster momentum in the lower pane as the daily RSI was unable to achieve overbought to confirm the most recent highs, resulting in an ugly potential bearish divergence.
One more thing to consider is the false start we saw from AUD/JPY last week: On May 10th, it broke to its highest level in over three years and pierced through the upper bounds of the current pennant formation. But it didn’t take long to give back these gains as the currency retreated into its prior range.
While the cross has remained resilient and continues to press on the upper trendline of its consolidation, the longer it takes to get the job done, the less likely it is to get it done at all…
This is why many investors and traders use time stops. Rangebound trends can add up to a significant amount of opportunity cost if you let them. They don’t just suck up your financial capital, but also your mental capital as trading these trendless messes can be frustrating.
What we’re left with is a bullish continuation pattern in a popular risk-on measure. We can only treat this chart as innocent until proven guilty -- we still want to err on the side of the underlying trend, which is UP.
At the same time, we want to be very cautious and mindful of the serious potential for this pattern to turn into a failed breakout, sparked by the bearish momentum divergence currently in play.
A breakdown below 84 would shift our outlook to neutral at best. The pair is a no-touch below this level.
More importantly, a downside resolution in AUD/JPY would put us on high alert for other failed breakouts from Commodities and Stock markets around the world.
On the other hand, a valid breakout from the current consolidation would support our bullish structural outlook and reflationary thesis and suggest that the next leg higher for risk-assets is likely underway.
But as long as this all-important FX cross keeps churning sideways and refuses to pick a direction, we should expect nothing but the same from other risk assets.
This is why we need to pay close attention to this chart whether we trade forex markets or not. It’s not about trading AUD/JPY -- it’s about using it as a tool to either confirm or disprove our thesis.
Right now, the jury is still out. We’ll be sure to follow up once the verdict is in!
