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Market Update: Higher for Longer

Written by Amelia Bourdeau
September 22, 2023
5 min read

US equity indexes were down on the week: S&P500 -2.9%, NASDAQ -3.6%, and DJIA -1.9%. The Fed's message of rates higher for longer that it emphasized once again at this week's FOMC meeting finally sunk in with market participants, triggering a US bond market rout (more on the Fed below). Higher US yields hit risk seeking, weighing on equity indexes. In the Friday Asia session, the US 10 year yield hit 4.50% and backed off to 4.43% in the New York session. On Wednesday, FOMC day, the US 2 year yield reached a high of 5.17% and ended the week at 5.11%. These yields are the highest since 2007 and 2006 respectively (chart below).

September FOMC Meeting:

The Fed kept the target range for the federal funds rate unchanged at 5.25% - 5.50% as expected. The decision was unanimous. The FOMC committee continued to characterize inflation as "elevated." It retained its hawkish bias by restating that "additional policy firming may be appropriate to return inflation to 2 percent over time."

A new Summary of Economic Projections ("SEP") was released and its revised forecasts reinforced the Fed's hawkishness. The dot plot showed that the year-end 2023 median for the policy rate target range remained at 5.625% (the median of a 5.50%-5.75% fed funds target range, so one more 25bp hike is expected). In addition, 12 out of 19 FOMC members think that it would be appropriate to hike by another 25bps by the end of this year. The median dot for 2024 rose to to 5.1% up from 4.6% in the June projection. If the FOMC hikes another 25bps, then this forecast implies 50bps of rate cuts in 2024. In comparison, the June projection forecasted 100bps of rate cuts in 2024. So the message from the Fed is higher rates for longer.

Fed fund futures are pricing the peak in the fed funds rate as December at 5.45%. The probability of a 25bp rate hike in December has increased. There are approximately 78bps of rate cuts priced in for 2024 - somewhat more than what the Fed has forecasted.

Chart: US 10 year yield, US 2 year yield, and Spread: 10s less 2s Sep 22 - Chart 3

Precious Metals:

Gold and silver prices remain capped due to high US bond yields and a strong USD. Precious metals would benefit from a dovish pivot in Fed language - signaling rate cuts are ahead. However, the US economy seems headed for a soft landing in 2023 and the Fed has emphasized higher rates for longer.

Looking ahead, as mentioned above, market participants are pricing in more rate cuts than the Fed for 2024, which could be supportive of precious metals prices should the cuts occur. In addition, there is significant event risk in 2024 due to the US presidential election. The uncertainty stemming from this event will cause market volatility. Therefore, from a portfolio standpoint, we see an allocation to precious metals including the diamond commodity as both necessary and beneficial from diversification and safe-haven stand-points.

The Diamond Market

DIAMINDX was unchanged on the week at USD 4,390. To review, the diamond industry is in the midst of an inventory overhang at the manufacturing and retail levels, which is weighing on natural diamond prices. Contributing factors are: softer US consumer spending on diamond jewelry after an aggressive run up in 2021-2022, a sharp slowdown in China's economy, and some competition from lab-grown diamonds.

However, the medium to longer term outlook remains positive for natural diamonds: the US economy (diamond jewelry's largest market) continues to avoid recession, which will support consumer spending into the year-end holiday shopping season and bridal jewelry sales are forecasted by Signet to pick up in 2024, as engagements increase post-pandemic. Longer-term, natural diamond supply is diminishing. Global rough production volume was estimated by the De Beers Group to be 121 million carats in 2022 - a decrease of two per cent from 2021. Ahead, Rio Tinto's Diavik mine, which produced 5 million carats in 2022, will approach its end of life by 2026. Beyond 2026, the De Beers Group notes in its 2023 Diamond Insight Report that several notable mines including Diavik are expected to cease production by 2030. These mines account for approximately 15 per cent of the global volumes produced in 2022 - a sharp supply drop.

The De Beers Group and Alrosa are the world's two largest producers of rough diamonds. Both had recent updates on supply. Tass news agency reported that Alrosa suspended rough diamond sales for September and October in order to attempt to stabilize prices. This action is in response to a request by the Gem and Jewelry Export Promotion Council of India ("GJEPC"), which reached out to global mining companies to ask for support "in temporarily adjusting the supply of rough diamonds to better align with the current demand." In August, Rapaport News reported that the De Beers Group is permitting sightholders to delay purchasing parts of their allocations of two-carat stones and larger for the remainder of the year. This applies to sights eight - 10, which take place in September, October, and December. These actions could help support natural diamond prices into year end, which is the holiday shopping period.

In other news, the De Beers Group is pushing back against lab grown diamonds by promoting natural diamonds. It announced that it is bringing back its iconic "A Diamond is Forever Campaign" with an additional $20 million investment to support consumer demand in natural diamonds for the 2023 holiday season in the US and China (the world's two largest consumers of diamond jewelry). In addition to running the campaign, De Beers Group will make the materials available to the trade for their use free of charge.

Lightbox, an independently managed subsidiary of the De Beers Group which sells lab grown diamonds ("LGD"), announced that it had ended its brief foray into selling LGD engagement rings. Lightbox will focus on "fashion jewelry" and will no longer sell engagement rings. In a press release, De Beers Group commented that "the engagement ring test reinforced existing insights into the wider LGD sector that indicate the commercial proposition for many LGD engagement ring offers is likely unsustainable, with retailers already needing to double the number of LGD carats sold every two years just to maintain a flat absolute gross profit."

Gold and Silver

Gold was basically flat on the week, just squeezing out a 0.1% gain to USD 1,925. Gold fell mid-week on the Fed's hawkish messaging and then recovered a bit on Friday as US bond yields back off their recent highs. For the month so far, gold has been in a USD 1,900 - 1,950 range. Silver rose 2.2% on the week to USD 23.55, breaking above the narrow trading range of USD 23.50 - 22.05 it had been in since September 6th. The gold-to-silver ratio fell to 81.76 this week from 83.52 last week. It has been cycling between 85 - 78 since the start of July.

The World Gold Council ("WGC") noted the global gold ETFs saw net outflows for August led by North America. WGC reported "Physically-backed gold ETFs experienced net outflows for the third straight month, losing US$2.5bn in August. As a result, total AUM fell 3% to US$209bn whilst holdings dropped by 46t to 3,341t."

Chart: Gold and Silver Prices have been capped by higher US bond yields Sep 22 - Chart 1


USD (DXY Index) was up 0.2% on the week to 105.53 at the time of writing. This is the tenth consecutive week of USD gains. The DXY Index is approaching resistance at 106.00, which is the top of its trading range year-to-date. The US economy is outperforming on a relative and absolute basis, which is supporting the USD along with continued hawkish Fed-speak.

EURUSD (the DXY Index's largest component) was relatively flat on the week ending at 1.0653. The single currency peaked in mid-July at 1.1275 and has moved lower since. GBPUSD fell 1.1% on the week to 1.2239 as the Bank of England ("BoE"), in a surprise decision, paused its rate hiking cycle at 5.25% likely due to a better than expected (i.e. weaker) inflation print. It was a close decision, 5 to 4, with BoE Governor Bailey casting the deciding vote. Market participants are anticipating that the BoE has reached its peak rate, while they are not so sure that the Fed has. Similar to the Fed, the BoE emphasized the policy rate will be restrictive for "sufficiently long." The JPY fell 0.3% vs USD as the BoJ remained relatively dovish at its monetary policy meeting this week. UDJPY ended the week at 148.34 - near levels of MoF intervention last fall.

Chart: USD (DXY Index), US 10 year yield, and EURUSD Sep 22 - Chart 2

Ahead: The main release to watch will be US PCE spending and prices for August released on Friday.

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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.