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Dollar index, gold on inflation watch

10 March 2021

Wall Street is expecting the headline CPI to register a year-on-year growth of 1.7%, which would be its highest reading since February 2020, before the pandemic took hold. And the vote on President Joe Biden’s pandemic relief bill, if passed, could strengthen investors’ belief that inflation will come roaring back.

Heightened inflation expectations are arguably the biggest talking point in global markets at the moment. And with this viewpoint gaining critical mass, investors are forced to reassess their portfolios.

Global investors are readying themselves for two major events today:

Both events could spur inflation expectations higher and trigger a massive reaction in Treasury yields, which could then jolt multiple major assets including the dollar, gold, and tech stocks. Today’s release of the CPI figures, though backward-looking, may lend more insight as to whether markets are getting ahead of themselves, or if their repositioning of late has been warranted.

92 DXY depends on higher-than-expected CPI

At the onset of 2021, most on Wall Street were firm in their belief that the US dollar would weaken further, based on the idea that faster inflation would erode the greenback’s purchasing power. Yet the dollar index (DXY) has advanced by more than 2% on a year-to-date basis, thank to those rising Treasury yields which in turn make dollar assets more appealing.

So here we are, with the Dollar index hovering just below the 92 mark at the time of writing, despite completing a head-and-shoulders pattern earlier this year.

The DXY’s pullback yesterday to around the 92 line was in tandem with moderating yields on Tuesday, as 10-year yields fell by some 7 basis points. There were technical factors at play as well, with the DXY’s 14-day relative strength index (RSI) hitting the 70 line. Such a technical event typically heralds an immediate pullback, as was the case overnight.

Although momentum is still pointing north, the dollar index’s ability to hang on to the 92 handle may depend on the upcoming inflation data release. A lower-than-expected CPI could mean further moderation in Treasury yields, which in turn should translate into the DXY paring more of its recent gains. However, the passage of the fiscal stimulus plan could convince investors to stick with their inflation outlook, which has supported the DXY so far in 2021.

Gold resurfaces above $1700 … for now

Gold prices have been able to come up for air above the psychologically-important $1700 level, thanks to the moderating dollar. Note that bullion has an inverse relationship with the greenback; each tends to move in the opposite direction to the other. From a technical perspective, spot gold’s reprieve comes after its 14-day RSI hit oversold territory which triggered the slight recovery.

Still, gold’s downward trend since posting its new record high in August remains firmly intact, with its 100-day simple moving average (SMA) having followed its 50-day counterpart to move below the 200-SMA. These technical events are referred to as a ‘death cross’.

Although gold has historically been seen as a hedge against inflation (preserve wealth when prices are rising), it now has to contend with rising Treasury yields too. Given the fact that bullion is a zero-yielding asset, higher Treasury yields make gold less appealing. And even though real yields (yields after stripping out inflation) remain in negative territory, gold is still finding it extremely tough to garner favour among investors in this current market climate. So if today’s events translate into higher yields, that could drag gold back below the $1700 once more.



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