Gold rebounded after the Federal Reserve prompted a sharp selloff in the US dollar, but the bigger question is whether that weakness has further to run. With the US Dollar Index approaching a major technical level and gold testing resistance, the next move for both markets may hinge on incoming US economic data.
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Post-FOMC Dollar Weakness Lifts Gold Within Its Trading Range
The slightly less hawkish than expected FOMC meeting resulted in the US dollar suffering its worst day in three months. While Fed funds futures still imply a 25-bp hike in September, expectations for a follow-up hike have been pushed back from December to March. The fact that three FOMC members voted for a hike at yesterday's meeting has done little to alter expectations beyond September, allowing the weaker US dollar to lift gold and WTI crude.
But with Kevin Warsh vowing to keep fighting inflation, the Fed may be forced to deliver another hawkish hike next month if employment data holds up and inflation reaccelerates—which it might, given the recent rally in crude oil prices driven by Middle East headlines.
This raises the question of how much further the US Dollar Index (DXY) can fall. The answer could prove pivotal for gold, as the extent of any further dollar weakness is likely to determine how far the current rebound can extend.
US Dollar Index (DXY) Technical Analysis
Crowded Dollar Longs Face Their First Test
I have questioned in recent weeks whether the US dollar was nearing a sentiment extreme in the futures market. Net-long exposure rose to a 10-year high of $42.6 billion, according to the latest COT report data. Asset managers also reduced gross longs in US Dollar Index futures, with net-long exposure retreating from last week's 18-month high.
While futures positioning points to a sentiment extreme, I suspect any pullback in the US dollar will be limited unless the economic data begin to roll over.
The weekly US Dollar Index chart shows a potential bull flag, which could allow for a modest pullback before a bullish breakout. However, if the index falls below 100, I would consider the bull flag invalidated, suggesting a deeper correction is underway.
Source: ICE, TradingView
100 Becomes the Line in the Sand
The daily chart shows bearish momentum has accelerated on the US Dollar Index after a double top formed around the June high. I suspect dollar bears are targeting a retest—and potentially a break—of the 100 level. However, the April and November highs could provide support, with a break below the 50-day EMA increasing the odds of a move towards 100. That could provide further support for gold in the near term, although I remain sceptical that we're about to witness a runaway rally.
Ultimately, my bias for a move to 102 remains intact while prices hold above 100. A break below 100 would bring the 200-day EMA and January's bullish trendline into focus.
Source: ICE, TradingView
Gold Futures (GC) Technical Analysis
While gold remains within a downtrend, seasonality tends to favour the bulls as we head into August. We can see on the daily chart that $4,000 has provided solid support, with prices gapping $2.20 higher at today's open following the Fed-induced weakness in the US dollar.
Prices have since retraced part of that opening gap, but the rebound highlights the potential for a move back towards the cycle highs around $4,200. Such a move could coincide with the US Dollar Index extending its pullback towards the 50-day EMA, although it would also increase the risk of a deeper correction from those highs.
With my bias favouring the DXY falling towards 100, I am also on guard for a breakout above $4,200, given the strength of the rebound from support.
Source: ICE, TradingView
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-- Written by Matt Simpson
Follow Matt on Twitter @cLeverEdge
