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Market Update: Downshift

Written by Amelia Bourdeau
January 13, 2023
5 min read

US equity indexes were up on the week: S&P 500 +2.7%, NASDAQ +4.8% and DJIA +2.0%. As inflation showed signs of easing with Thursday's US US CPI release for December (more below), US Treasury yields moved lower and US equity indexes moved higher.

Signaling the possibility in a further downshift of the pace of rate hikes, Philadelphia Fed President Harker, a FOMC voter, spoke Thursday saying that rate hikes of 25bps "will be appropriate going forward." The Fed hiked the fed funds rate by 50bps in December, a slower pace that the 75bp rate hikes previously. The next FOMC announcement is February 1. Market participants scaled back the pricing for that meeting, according to futures contracts, to expectations of a 27bp hike. However, the Fed has emphasized previously that it is the terminal rate, which the Fed's median forecast puts at 5.1% for year-end, which matters more than the pace of tightening.

On the Data Front:

US headline and core CPI came in on expectations, headline CPI fell -0.1% m/m, led by a -4.5% m/m decline in energy prices, and core CPI rose 0.3%, m/m. Headline CPI moderated to 6.5% y/y in December from 7.1% y/y in November. This is the series' sixth consecutive month of moderation down from its 9.1% y/y peak in June. Core CPI moderated to 5.7% y/y in December from 6.0% y/y in November.

U of Michigan sentiment/inflation expectations: The January preliminary figures were released on Friday. Sentiment came in above expectations at 64.6 and up from the December read of 59.7. Sentiment remained low historically but continued to improve for the second consecutive month. On inflation expectations: year-ahead inflation expectations receded for the fourth straight month, falling to 4.0% in January from 4.4% in December. The current reading, though, remains well above the 2.3-3.0% range seen in the two years prior to the pandemic. Long-run inflation expectations were little changed from December at 3.0%, staying within the narrow 2.9-3.1% range for 17 of the last 18 months.

Ahead next week - select events include:

Davos, Fed-speak from 2023 FOMC voters (market participants will gauge the Fed's hawkishness), ECB Minutes, CPI reads from Canada, Germany, UK, Eurozone, and Japan.

The World Economic Forum, "Cooperation in a Fragmented World," will take place 16-20 January in Davos. See here for schedule of sessions.

Monday, Jan 16:

BoE's Bailey testifies on financial stability; US Holiday

Tuesday, Jan 17:

Germany CPI (Dec); Canada CPI (Dec)

Wednesday, Jan 18:

BoJ policy rate meeting; UK CPI (Dec), EZ CPI (Dec F), US Retail Sales (Dec), Philly Fed President Harker (voter) on the Economic Outlook; Dallas Fed Pres Logan (voter) speaks at U of Austin

Thursday, Jan 19:

Norway monetary policy decision, ECB Minutes Dec 2022 Policy Meeting; ECB President LaGarde speaks at WEF; ECB's Schnabel speaks in webinar on monetary policy; Fed Vice Chair Brainard speaks on the economic Outlook.

Friday, Jan 20:

Japan CPI (Dec), NY Fed Pres Williams speaks (voter) at the Fixed Income Analysts Society of NY; Fed Gov Waller speaks on the Economic Outlook.

Chart: US Headline CPI (6 month annualized % change) - A moderation in H2 2022 US CPI (6 Months, Annualized - Change) (1)

USD Remains on its Backfoot

The USD (DXY Index) finished the week down approximately 1.6% at 102.19 (at the time of writing). The DXY Index shifted into a new, lower trading range on Friday, January 6th post the US payroll report and the disappointing US ISM Service result released that day. The DXY Index first moved to 103.50-103.00 and then lower post this week's CPI release to 103.00-102.00. This downshift was driven by the lower US 10 year yield (chart below).

EURUSD, the DXY's largest component, continued its upward trend post last Friday's US data. It ended the week at for a gain of approximately 1.8% to end the week at 1.0829 area (at the time of writing). The first weeks of the new year have seen the single currency break topside 1.0700 and 1.0800 due to USD weakness and likely relief from a warmer that expected winter in Europe. EURGBP was sitting on its 200d movg of 0.8851 late Friday. The cross has been ranging 0.8769-0.8896 since late December.

JPY, the DXY's second largest component, was the best performing currency in the G10 for the week. JPY gained 3.3% vs USD, boosted by scaled back Fed rate hiking expectations (in terms of pace). JPY gained 2.4% vs. USD on Thursday, the day of the US CPI release.

Chart: US 10 year yield, USD - DXY Index, EURUSD. EURUSD breaks higher, DXY Index breaks into lower trading ranges as lower US 10 year yield weighs on it. Source: DS, Bloomberg

Chart - 2 (1)

The Diamond Commodity

DIAMINDX fell 0.36% on the week. The outlook for diamonds among dealers and jewelers is uncertain given the concern about a slowing US economy. The US accounts for just over 50% of global diamond jewelry demand. On a positive note for the consumer outlook, the US jobs market remains strong so far despite the Fed rate hikes. However, policy tightening works with a lag so the full impact has not been felt yet. Rapaport reports that in the US, high end jewelry demand remains robust.

China, which is the second largest market for global diamond jewelry demand at under 20%, is poised for increased economic activity ahead with the end of its covid controls. Chow Tai Fook, greater China's largest jeweler, noted the following in its FY2023 Interim Results publication: "We remain positive on the mid- to long-term growth prospects of the Mainland‘s economy and jewellery market...In Hong Kong, we expect pent-up demand for bridal jewellery and a gradual easing of social distancing measures to drive growth in 2HFY2023." (note, 2HFY 2023 is underway currently). Revenue during 1HFY2023 increased by 5.3% y/y. The Retail network expanded to 6,948 POS as of 30 September 2022, with a net addition of 933 Chow Tai Fook jewelry POS in the Mainland during the period. Core operating profit declined by 2.7% y/y.

Seasonally, heading into the new year, DIAMINDX has appreciated in January and February on average over the past 5 years into US Valentine's Day and China's Lunar New Year.

Ahead, next week, is the DeBeers' sight (Sight 1: 16 January - 20 January), which will garner interest as diamond dealers watch rough prices at the start of the new year.

Gold rose 2.9% on the the week boosted by both a weaker USD and headlines about the PBoC increasing its gold reserves. According to the World Gold Council, the People's Bank of china ("PBoC") reported increase of 32t – the largest central bank purchase of November and China’s first announced increase in its gold reserves since September 2019. Post NY market close on Friday evening January 6, the PBoC reported an additional increase in its gold reserves for December of 30t - buying for the second consecutive month. This supported gold into Monday's open when it traded to USD 1,880 area. Gold ended the week above USD 1,900 at USD 1,919.37 area.

Silver gained 1.9% on the week closing on Friday above the key USD 24.00 at USD 24.28. USD 24.00-24.50 remains a strong area of resistance. Similar to gold, silver benefitted from USD weakening. Gold outperformed silver, however, sending the gold-to-silver ratio higher this week, ending at 79.08 (at the time of writing).

2023 is likely to be a challenging time for markets with uncertainty remaining about the path of inflation, the fed funds rate, and the US economy. Geopolitical risk also remains. As such, investors will likely continue to look for portfolio diversification in the form of commodities and alternative investments. The diamond commodity is uncorrelated, offering a diversification opportunity.

Chart: USD - DXY Index (inverted, rs), Gold, and Silver. USD weakness (DXY moving up) has led to gains in Gold and Silver. Source: DS, Bloomberg Screenshot 2023-01-13 at 6.36.39 PM

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Disclaimer: This report has been prepared by the Strategy Team of Diamond Standard Inc. (“Diamond Standard”). This report, while in preparation, may have been discussed with or reviewed by persons outside of the Strategy Team, both within and outside Diamond Standard. While this report may discuss implications of legislative, regulatory and economic policy developments for industry sectors, it does not attempt to distinguish among the prospects or performance of, or provide analysis of, individual companies and does not recommend any individual security or an investment in any individual company and should not be relied upon in making investment decisions with respect to individual companies or securities.
Opinions and estimates offered constitute our judgement and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. Under no circumstances does the information contained within represent a recommendation to buy, hold or sell any security, and it should not be assumed that the transactions discussed were or will prove to be profitable.