US dollar rebound puts gold bear pennant in focus

• DXY rebound helped by rising front-end US yields
• DXY-gold inverse correlation strengthens to -0.92 over past week
• Gold’s bear pennant warns of renewed downside.

The US dollar is finding support as front-end Treasury yields push higher following Kevin Warsh’s hawkish Jackson Hole speech. The renewed bid is weighing on gold, which is coiling within a bearish technical structure that warns of another potential leg lower.

Dollar bid returns

Source: TradingView

As noted in a separate post released in August, which flagged the potential for prior US dollar weakness to reverse, DXY has regained its mojo over the past week, rebounding strongly after twin failures beneath a support zone including the 50% retracement of the January to June bull move. That has seen it reclaim the 200-day moving average and the 38.2% Fib retracement of the same move, before eventually stalling at the 100-day moving average on Monday.

However, having tested the 38.2% Fib again in early trade on Tuesday, the price has rebounded over the remainder of the Asian session, pointing to the potential for a retest of the 100-day moving average, then resistance at 100 overhead.

The price action in DXY closely mirrors shifts in the shape of the US Fed funds futures curve between June and December this year, with tightening priced by year-end rising to 34 basis points, up from less than 25 basis points before Kevin Warsh’s speech at Jackson Hole last Friday.

DXY tracking front end yields again

Source: TradingView, FOREX.com

The correlation matrix above shows a sharp increase in DXY’s positive relationship with front-end US yields over the past week, particularly the two-year tenor, where the correlation has jumped to 0.87. The relationship diminishes the further out the curve you go, falling to just 0.16 with the 30-year.

At the same time, DXY’s already strong inverse relationship with gold has strengthened further, lifting to -0.92 over the past five days, hinting that further dollar upside could spark renewed downside in gold.

Looking at the price action in XAU/USD, those risks may already be materialising.

Gold threatens another leg lower

Source: TradingView

Gold bulls will still be licking their wounds after Friday’s lurch lower, which saw the price take out the uptrend that had been in place from before the bullish breakout in early August. In the period since, the price has been consolidating in a narrowing range, struggling beneath $4,450, a level that acted as both support and resistance over recent weeks.

The abrupt downward move followed by the contracting price range resembles a bear pennant, warning of a potential resumption of the prior bearish move and retest of lower levels. The first of which is $4,400, where the price bounced on Friday, followed by $4,367, which has previously acted as both support and resistance, then $4,315, which provided support for periods in August.

The message from the oscillators is one of sustained downside pressure, with RSI (14) pushing back towards oversold territory at 30. MACD confirms the bearish message, continuing to trade beneath the signal line in negative territory.

Of course, if the price manages to break above pennant resistance, it would point to the potential for a move back towards resistance at $4,525.