Severe "overselling," concentrated short positions, and interest rate spread support, the dollar may "technically rebound" at any time, affecting gold?

After the US dollar experienced a nearly 10% plunge, technical indicators and excessive bearish sentiment suggest that a rebound may be imminent.

Following multiple threats from Trump to fire Federal Reserve Chairman Jerome Powell, and the increasing risk of a recession in the US leading to a "sell America" trade, the dollar fell to its lowest level since December 2023 this week, showing a significant divergence from the trend of the 10-year US Treasury yield.

From a technical analysis perspective, the dollar's decline has reached a critical level: the dollar index has dropped nearly 10% since its peak in February this year, and such a magnitude of adjustment has historically often been accompanied by short-term rebounds.

In terms of indicators, the relative strength index (RSI) of the dollar index has fallen to its lowest level since 2020. Notably, the RSI fell to a similar level in July 2023, after which the dollar rebounded by about 7% in the following months.

The excessive bearish sentiment towards the dollar is also brewing a technical rebound. According to data from the Commodity Futures Trading Commission, speculators' net short positions on the dollar and 10 currencies, as well as the Dollar Index, surged to $40 billion last week, the highest level since October last year.

This extreme market positioning often serves as a precursor to price reversals, a situation that has occurred multiple times in the past. The oversold condition combined with one-sided investor sentiment creates a technical foundation for a dollar rebound.

On the fundamental side, data from the Federal Reserve shows that in the two weeks ending April 16, overseas central banks and international organizations increased their holdings of US Treasury bonds by more than $10 billion. This indicates that the plunge in US Treasury bonds has not deterred reserve managers from increasing their holdings, which is favorable for the dollar.

After adjusting for inflation, the dollar still maintains a yield premium against other major currencies, which may also provide momentum for a dollar rebound.

Ken Cheung, Chief Asian Foreign Exchange Strategist at Mizuho Bank Ltd., stated that there is a chance for a short-term rebound in the dollar, but negative news may limit its gains:

The dollar is poised for a rebound—whether brief or lasting.

A large number of bearish positions, technical factors, and real yield differentials suggest that the dollar may rebound.

Dollar Rebound, Gold Suffers?

CICC believes that the weak expectations for the dollar are the main reason for the recent continuous rise in gold. The current dollar index at 98 is an important support level on a monthly basis; if it breaks down, we will look at 89.

In the short term, the dollar remains under pressure, but the extent is limited, gradually recovering in the third and fourth quarters, which may lead to a correction in gold. Given the current real interest rates and the uncertainty of maintaining the current levels (this assumption is quite strong), the current gold price implies that the dollar needs to drop to 86 (currently at 98)

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