The recovery could end if US CPI data confirms a 75 basis point Fed hike

  • Gold closed the third consecutive week in positive territory.
  • $1,780 is the key technical level for XAU/USD.
  • July inflation data from the US could trigger a strong reaction next week.

Gold started August on solid footing and climbed towards $1,800 before erasing some of its weekly gains on Friday. The sharp drop in US Treasury yields and the lackluster performance of the dollar helped XAU/USD gain more than 1% in the first half of the week. However, after July’s impressive US jobs report, gold reversed direction. Next week’s July inflation report from the US will be the next big catalyst for the pair.

What happened last week?

The dollar’s sell-off continued early in the week and the US dollar index fell to its lowest level in almost a month below 106.00. Data released by the ISM showed on Monday that the manufacturing PMI survey’s price paid index fell to 60 in July from 78.5 in June, indicating a significant easing of price pressures. Investors continued to cut bets on the Fed’s September rate hike by 75 basis points (bps) on the data and gold closed the fourth straight day in positive territory.

As safe-haven flows began to dominate financial markets, the greenback regained strength and failed to allow XAU/USD to maintain its bullish momentum. Reports that U.S. House of Representatives Speaker Nancy Pelosi was planning to visit Taiwan despite stern warnings from China sparked risk aversion in markets on Tuesday. Additionally, hawkish comments from Fed officials helped the USD continue to outperform its rivals.

Chicago Fed Chairman Charles Evans said a 50 basis point rate hike would be a “reasonable valuation” for the September meeting, but left the door open for a 75 basis point hike . Additionally, St. Louis Federal Reserve Chairman James Bullard has said he would like to raise the policy rate to the 3.75 to 4% range by the end of this year and the Chairman of the San Francisco Fed May Daly argued that markets were getting ahead of themselves in expecting rate cuts next year.

Nonetheless, investors breathed a sigh of relief after Pelosi landed in Taiwan and the dollar’s rally fizzled out mid-week. The ISM Services PMI improved to 56.7 in July from 55.3 in June, but the dollar remained behind with the prices paid index falling to 72.3, against a market expectation of 81, 6 against 80.1.

On Thursday, the XAU/USD pair continued its bullish momentum amid falling global bond yields. Following its August policy meeting, the Bank of England (BOE) announced that it had raised its key rate by 50 basis points to 1.75% as expected. On a worrying note, the bank said it now expects the UK economy to tip into recession in the final quarter of the year and continue to contract throughout 2023. Although the dollar captured some Sterling outflows along with the market reaction, XAU/GBP gaining more than 1% on a daily basis on Thursday showed that gold demand remains robust.

The U.S. Bureau of Labor Statistics reported on Friday that U.S. nonfarm payrolls rose by 528,000 in July, well beating market forecasts of 250,000. Underlying details from the report revealed that the rate unemployment rate fell to 3.5% and annual wage inflation, as measured by the average hourly wage, remained stable at 5.2%. The yield on 10-year US Treasury bonds gained more than 5% and rose above 2.8% after the data, leading to a sharp turnaround in XAU/USD heading into the weekend.

Next week

Trade balance data from China will be closely watched by market participants early in the week. In the event of a bigger than expected decline in the trade surplus, gold could struggle to gain strength and vice versa. Since the start of the summer, disappointing data releases from China have weighed on gold prices due to their potential negative impact on the demand outlook.

On Wednesday, the US Bureau of Labor Statistics will release the Consumer Price Index (CPI) figures for July. On an annual basis, CPI inflation is expected to decline slightly to 8.9% from 9.1% in June. The market’s reaction to the inflation data should be fairly straightforward with a higher than expected CPI print triggering a rally in the dollar and a weak reading forcing the currency to face renewed selling pressure.

The inflation report is likely to significantly affect the market’s assessment of the size of the Fed’s rate hike in September. Currently, the CME Group’s FedWatch tool shows that there is a 66.5% chance that the Fed will opt for a 75 basis point rate hike. Given that Fed officials have refrained from outrightly rejecting such a rate move, a CPI above 9% should allow Fed hawkish bets to continue to dominate market action and increase downside pressure. on gold.

On Friday, the University of Michigan will release its Flash Consumer Sentiment Index for August. Rather than the overall confidence data, investors will pay particular attention to the long-term inflation expectations component of the survey. In the final July version, long-term inflation expectations stood at 2.8%. Any reading above 3% could help the dollar strengthen and hurt XAU/USD, while a print of 2.8% or lower should weigh on the USD.

Gold Technical Outlook

The Relative Strength Index (RSI) indicator on the daily chart declined towards 50 on Friday, indicating a loss of bullish momentum.

At the time of writing, gold was trading slightly below $1,780 where the 23.6% Fibonacci retracement of the last downtrend and the descending trend line meet. In order to remain technically bullish, XAU/USD must confirm this level as support. In this scenario, $1,800 (50-day SMA psychological level) and $1,830 (38.2% Fibonacci Retracement) line up as the next bullish targets.

On the other hand, the first support is located at $1,740 (20-day SMA) ahead of $1,700 (psychological level) and $1,680 (low from July 21, static level from March 2021).

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