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Silver analysis: Reversal in sight amid Fed hawkish risk and bearish RSI divergence?

By Piero Cingari

14:01, 12 December 2022

Silver bar and ingots on chart of financial report. Silver price market concept. – Photo

Following a stunning 33% rally from October lows, silver now faces a pivotal week for its future, with the November US CPI release on Tuesday and the FOMC meeting on Wednesday.

The reversal of the dollar and real interest rates in the United States propelled silver higher, with favorable news from China's reopenings fueling the rise.

But this week's macro events pose risks that should not be taken lightly for an asset like silver which is extremely sensitive to US interest rates.

After producer price inflation (PPI) came in higher than predicted last Friday, consumer price inflation (CPI) may also surprise higher in November. The market anticipates headline inflation to fall to 7.3% from 7.7% in October, and core inflation to fall to 6.1% from 6.3%. As a result, most of the good news seems priced and any upside surprise might spur abrupt market reactions.

Regarding the Fed, although a 50bps looks to be a done deal for Wednesday, the risk component there is undoubtedly provided by the new dot plot, which may indicate a higher terminal rate than what the market has presently priced in and to continue with restrictive interest rates for longer.

Technically, a bearish RSI divergence pattern just formed on the daily silver chart, as prices hit the 6-month 123.6% Fibonacci level at 23.65, but the RSI failed to surge higher. Overall, after breaking above the ascending channel established in August 2022, silver prices may retrace within the $21-22 area in the near term.

Weaker USD and China’s reopening hopes drove silver’s rally

Silver price and US dollar index: Negative correlation – Photo: Capital.com, Source: Tradingview

Silver's rebound from its mid-October low of $18.1 was propelled by a declining dollar trend and increased hopes for a reopening in China, which together pushed the metal's price up by around 33% over the past two months.

The US dollar index (DXY) dropped by approximately 8% from its highs in September as markets celebrated a lower-than-expected US CPI in October (7.7% versus 8%), which drove rising speculation on a Fed Pivot in H1 2023.

Nominal yields on US Treasuries fell, with both the 10-year and 30-year yields returning to 3.5%, driving US real rates lower as inflation expectations ticked up. Money market speculators are now expecting the US terminal rate to peak at 4.90-4.95% in May, followed by 40 basis points of Fed cuts in H2 2023.

The correlation between the US dollar index and silver over the past 60 days is -0.91, demonstrating an almost linear negative link between the two assets.

Another recent bullish catalyst for silver was the easing of Covid restrictions in China. This effectively opened the door to a new driver, providing growth aspirations for silver in 2023, independent from a simple negative link with US interest rates. 

Since China announced additional steps to relieve Covid lockdowns, silver has outperformed other metals such as gold, copper, palladium, platinum, and aluminium. This is likely due to the fact that silver is both a precious metal and a raw material with rising industrial usage due to the green transition. 

Silver relative performance vs gold, copper, palladium, platinum and aluminium since November 2022

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Silver outperformed other metals since China's reopening talks – Photo: Capital.com, Source: Tradingview

Silver faces US CPI upside surprise risks

Higher-than-anticipated US inflation in November acts as a drag for silver. The market anticipates that US inflation will continue to fall in November to 7.3%, down from 7.7% in October, which missed market estimates of 8% and sparked a dollar's downtrend. 

However, the positive news for the inflation trajectory now looks to be sufficiently priced in by the interest rate market, as markets already discount Fed to slash interest rates next summer. 

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On the other hand, the producer inflation data out last Friday did not speak very favourably (0.3% m/m vs 0.2% expected) and as a result, it may lead to undesirable implications for the bulls if the CPI number came out over expectations.

CPI prints above 7.5% y/y or perhaps the 7.7% seen in October might exert significant negative pressure on silver, whilst for fresh upsides, inflation should likely fall below the psychological level of 7%.

Silver and FOMC risk: Hawkish for longer?

Silver has rallied more than the drop in US 10-year real yield would have implied – Photo: Capital.com

The FOMC meeting on Wednesday is another key negative risk for silver this week. 

Fed Chair Powell said there was "more room to hike" and that interest rates should stay "restrictive for some time" to avoid making the same mistakes as in the past, however, markets have been pricing in a more "dovish" Fed on the back on declining inflation trajectory and rising recession risks. 

Even though a 50 basis point hike in December is a done deal, there is a growing chance that the last FOMC meeting in 2022 won't meet the dovish market expectations. This could cause a sudden reversal of the moves seen in the past two months.

The Federal Reserve is likely to reiterate the need of maintaining real positive rates throughout the Treasury curve for longer, in order to combat inflation. This hawkish stance may be bolstered further if the CPI comes in higher than predicted.

The revised Fed economic predictions will also be important to watch, with the dot plot reflecting the board's choice for the course of interest rates. Fed funds were predicted to reach their peak in 2023 at 4.6%, but Powell emphasized that the forecast will be raised.

Anything beyond 5% is likely to startle the market, which presently expects the Fed's terminal rate to peak in May 2023 at 4.9%.

Silver chart analysis: pullback in sight after bearish RSI divergence?

Silver technical analysis as of December 12, 2022 – Photo: Capital.com, Source: Tradingview

A RSI bearish divergence has just formed in the silver daily chart, as prices reached 23.66, extending past December highs (23.48), while the momentum oscillator moved downward.

The strong bullish price action seen in December also breached the four-month ascending channel, encountering resistance at 23.66 which corresponds to the 123.6% Fibonacci level of the 6-month low-high range.

As hawkish Fed threats loom, I think that the bulls' strength may start to wane a little here, giving room for price reversals. 

In the event of stronger-than-expected CPI data, 22.5 might serve as a first support target for silver. There is a chance that this level will be tested by bears during the FOMC meeting and Powell's press conference with the possibility of a return to the 21.90 zone (20-day moving average).

A drop to 21.44 (78.6% Fibonacci) or 21.2 (200dma) by the end of the week would be more challenging at the moment, however, these levels should not be ignored as an end-of-year target in the event of a high CPI and hawkish Fed developments.

Markets in this article

Silver
Silver
24.595 USD
-0.054 -0.220%
Aluminum
Aluminium Spot
2313.0 USD
3.8 +0.170%
Copper
Copper
4.00700 USD
-0.01894 -0.470%
Palladium
Palladium
1001.50 USD
12.2 +1.240%
Platinum
Platinum
903.00 USD
3.15 +0.350%

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