Rising bond yields and the dollar will likely remain key areas of focus for investors this week. The ten year note yield has been flirting with the three percent yield level, and has already caused some significant investor anxiety and market volatility.

After trading in a range from 88 to 90 or so, the dollar index has put together a bit of a rally in recent sessions, pushing prices to almost 91.50. Whether or not the recent run higher is sustainable is another question. 

The dollar has been propped up by higher yields and an unwinding of the short dollar trade, which had gotten considerably crowded. Although higher yields may provide some support for the currency, a swift reversal in yields also has the potential to bring the dollar right back into its previous range, or even lower.

Wednesday’s FOMC meeting announcement could potentially have a significant impact on both yields and the dollar. No action is expected from the central bank at this meeting, however, investors will be very interested in the central bank’s statement. Markets have now priced in three additional rate hikes in 2018, while the Fed sees only two. A hawkish tone in the central bank’s commentary could set the stage for a June rate hike, fueling further dollar upside in the process. Such a scenario could potentially have a knee-jerk, negative impact on gold prices. A lack of any hawkish rhetoric, or even a more dovish tone, however, could take the wind from the dollar’s sails and fuel buying in hard assets like gold.

Following the FOMC meeting, investors will then turn their attention to Friday’s non-farm payrolls data for April. The economy is at or near full employment, and investors will likely be more concerned with wage data as opposed to the headline number. Rising wages could point to further economic strength, and the potential for a faster rate of  monetary policy normalization. Higher wages would also indicate that inflationary pressures are on the rise, which could be considered very bullish for gold.

Further signs of inflation could keep upward pressure on bond yields. If the benchmark ten year note is able to maintain a yield of three percent, positive economic data could potentially send yields sharply higher in short order. Some analysts have already suggested that a 3.5 to 4 percent yield is likely in the cards in the months ahead.

Although higher yields may have weighed on gold in recent weeks, an ongoing move higher in rates could potentially be a major bullish catalyst for gold. The only reason the Fed would look to become significantly more aggressive with rates is if falls behind the inflation curve. If that proves to be the case, investors could seek out hard assets like gold to provide a hedge against rising prices and a decline in purchasing power. Not only that, but higher rates may pressure stocks, as more attractive yields compete for investor capital. Much of that capital could, however, find its way into the gold market as investors seek out alternatives with more potential upside.

The gold market has numerous bullish factors currently at work that could potentially take prices sharply higher in the weeks and months ahead. Although the numerous geopolitical headwinds being seen around the globe could play a role in higher gold, there is likely a far more significant issue that could be behind any upside breakout.

The dollar index has struggled to put together any sustainable move to the upside. The currency’s lack of traction has caused the greenback to trade within a range, moving sideways between the 88 and 90 levels. Although the dollar bulls have stopped the bleeding- at least for now, the currency is facing some serious challenges that could not only prohibit any moves higher but could set the stage for a dramatic decline.

The dollar is not far from its recent lows around 88, and another test of the recent lows could give way to a much larger decline. The notion of an even weaker dollar could be the primary force fueling action in the gold market. Despite numerous other bullish inputs, a weaker U.S. currency could propel gold sharply higher from current levels.

A bearish case for the dollar has become quite compelling in recent months. An exploding deficit, relatively low interest rates and the global reflation trade have all weighed on the dollar, and may continue to do so throughout 2018. Of particular note is the fact that the dollar has not seen much of a bounce even as the geopolitical landscape becomes increasingly unstable. This could be indicative of an investor preference towards hard assets like gold in lieu of dollars.

To put it simply, recent price action in gold may be a dollar trade and not a fear trade.

The trading week ahead will bring some important pieces of data as well as some commentary from Fed officials. The Fed’s Beige Book due for release on Wednesday as well as Leading Indicators to be released on Thursday could be focal points for investors this week.

The Fed has recently reiterated its plans for further rate hikes in the months ahead, and any surprises from the Fed have the potential to be market moving. Despite its plans for further hikes this year, however, the dollar could still continue to lose ground as other global central banks take a more aggressive approach towards normalizing monetary policy.

The gold market could potentially find itself in a bullish position either way. If the Fed raises rates as planned, or even becomes more aggressive with a larger or fourth rate hike, stock investors may become weary and begin exiting the market in larger numbers. As risk aversion increases, investors may seek out alternatives.

The central bank could, however, also elect to keep its foot on the gas and refrain from additional hikes at this time. St. Louis Fed President James Bullard was quoted recently in an article from marketwatch.com, and questioned the need for further hikes at this time. According to the article, Bullard referred to the current level of rates as being “quite close to neutral right now,” meaning that rates are neither fueling nor dampening inflationary pressures. Mr. Bullard also reportedly questioned the need to implement rate hikes in order to counter temporary fiscal stimuli such as the recent tax cuts or spending bill passed by Congress.

Bullard’s opinion appears to be in stark contrast to that of some other Fed officials, who have voiced a far more hawkish view. Either way, there appears to be some considerable disagreement between the policy hawks and doves that could fuel market uncertainty.

Not only would a lack of action from the Fed send mixed signals to the markets, but it could also have a huge impact on the dollar which may already be on very thin ice.