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Recovery could end if US CPI data confirms 75 bps Fed hike

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

Gold started the month of August on a firm footing and climbed toward $1,800 before erasing a portion of its weekly gains on Friday. The sharp decline witnessed in the US Treasury bond yields and the dollar’s uninspiring performance allowed XAU/USD to gain more than 1% during the first half of the week. Following the impressive July jobs report from the US, however, gold reversed its direction. The July inflation report from the US next week will be the next significant catalyst for the pair.

What happened last week?

The dollar sell-off continued at the beginning of the week and the US Dollar Index declined to its weakest level in nearly a month below 106.00. The data published by the ISM revealed on Monday that the Prices Paid Index of the Manufacturing PMI survey declined to 60 in July from 78.5 in June, revealing a significant softening in price pressures. Investors continued to scale back 75 basis points (bps) Fed rate hike bets in September on this data and gold closed the fourth straight day in positive territory.

With safe-haven flows starting to dominate the financial markets, however, the greenback regathered its strength and didn’t allow XAU/USD to preserve its bullish momentum. Reports of US House of Representatives Speaker Nancy Pelosi planning to visit Taiwan despite China’s stern warnings caused markets to turn risk-averse on Tuesday. Additionally, hawkish comments from Fed officials helped the USD continue to outperform its rivals.

Chicago Fed President Charles Evans said that a 50 bps rate hike would be a “reasonable assessment” for the September meeting but left the door open for a 75 bps increase. Moreover, St. Louis Federal Reserve Bank President James Bullard said that he would want to get the policy rate to the 3.75-4% range by the end of this year and San Francisco Fed President May Daly argued that markets were getting ahead of themselves by expecting rate cuts next year.

Nevertheless, investors breathed a sigh of relief after Pelosi landed in Taiwan and the dollar recovery lost its steam midweek. The ISM Services PMI improved to 56.7 in July from 55.3 in June but the dollar stayed on the back foot with the Prices Paid Index falling to 72.3, compared to the market expectation of 81.6, from 80.1.

On Thursday, XAU/USD gathered further bullish momentum amid falling global bond yields. Following its August policy meeting, the Bank of England (BOE) announced that it hiked its policy rate by 50 bps to 1.75% as expected. On a concerning note, the bank said that it was now projecting the UK economy to tip into recession in the last quarter of the year and continue to contract throughout 2023. Although the dollar captured some of the outflows out of the British pound with the immediate market reaction, the fact that XAU/GBP gained more than 1% on a daily basis on Thursday showed that gold demand remained robust.

The US Bureau of Labor Statistics announced on Friday that Nonfarm Payrolls in the US grew by 528,000 in July, surpassing the market forecast of 250,000 by a wide margin. Underlying details of the report revealed that the Unemployment Rate declined to 3.5% and the annual wage inflation, as measured by the Average Hourly Earnings, remained steady at 5.2%. The 10-year US Treasury bond yield gained more than 5% and climbed above 2.8% after these data, causing XAU/USD to make a sharp U-turn ahead of the weekend.

next week

Trade Balance data from China will be closely watched by market participants at the beginning of the week. In case there is a bigger-than-expected decline in the trade surplus, gold could find it difficult to gather strength and vice versa. Since early summer, disappointing data releases from China have been weighing on gold prices amid 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 a yearly basis, the CPI inflation is forecast to edge lower to 8.9% from 9.1% in June. The market reaction to inflation data should be pretty straightforward with a higher-than-expected CPI print triggering a dollar rally and a soft reading forcing the currency to face renewed selling pressure.

The inflation report is likely to significantly affect the market pricing of the size of the Fed’s September rate hike. Currently, the CME Group FedWatch Tool shows that there is a 66.5% probability of the Fed opting for a 75 bps rate increase. Since Fed officials refrained from outright dismissing such a rate move, a CPI reading above 9% should allow hawkish Fed bets to continue to dominate the market action and ramp up the bearish pressure on gold.

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

Gold technical outlook

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

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

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


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