Week in Review: Off to a Busy Start

On the data front: US ISM Manufacturing came in at 48.4 for December, in line with the consensus expectation, but below the 50 level for the second consecutive month, indicating that the manufacturing sector continues to be in recession. On a positive note, the prices index fell 3.6 percentage points in December to 39.4 percent - raw materials prices decreased for the third straight month after a 28-month period in “increasing” territory.

US ISM Services came in below expectations at 49.6 in December down from 56.5 in November. The December result indicates, after 30 consecutive months of growth, that the services sector contracted in December for the first time since May 2020. The employment index came in at 49.8, which is in contraction territory. However, this was a result of both "a combination of decreased hiring due to economic uncertainty and an inability to backfill open positions." The prices index fell 2.4 percentage points to 67.6.

US Nonfarm Payrolls, released Friday, rose by 223k in December, above the consensus expectation, but the smallest increase in two years. The unemployment rate fell to 3.5% from 3.6% in November, reminding us that the labor market is tight. Average hourly earnings moderated to 0.3%, a softer gain than the downwardly revised 0.4% monthly increase in November. Average hourly earnings are still strong, however, at 4.6% y/y. The December FOMC Minutes were released Wednesday. At that meeting, the FOMC hiked the fed funds rate 50bps, a slowing from the previous 75bp rate hike pace. In the meeting's minutes, the committee emphasized its ongoing inflation fight and had a blunt statement on the possibility of rate cuts in 2023.Key quotes below:

On inflation: "Participants concurred that the inflation data received for October and November showed welcome reductions in the monthly pace of price increases, but they stressed that it would take substantially more evidence of progress to be confident that inflation was on a sustained downward path."

On the policy outlook: "...participants continued to anticipate that ongoing increases in the target range for the federal funds rate would be appropriate to achieve the Committee’s objectives."

On rate cuts: "No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023. Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time.The dot plot from the December meeting's Summary of Economic Projections ("SEP") showed the median estimate for the fed funds rate at the end of 2023 rose to 5.00%-5.25%, 50 bps higher than the September SEP. Market pricing as of Friday afternoon still implies that the federal funds rate will peak in June at 4.95% and finish the year lower at around 4.50% - a different, less hawkish view, than the FOMC participants expressed in the December Minutes."

Table: Select Indices & Commodities - Annual, Monthly, Weekly Changes

USD - Steady to Moderately Stronger

The USD (DXY Index) finished the week modestly higher rising 0.4%. The DXY fell approximately 1.7% intraday in Friday post US payrolls and the disappointing US ISM Service result (discussed above), moving from 105.62 to 103.89.

For December, the DXY Index declined 2.3% m/m as gains in JPY and EUR kept the USD on its back foot, gaining 3.2% and 1.8% vs USD respectively.

USDJPY ranged 129.50-134.74 this week, ending it at 132.05. JPY gained 1% vs USD on Friday, as the USD weakened. Looking back at late December, in a surprise move, the BoJ changed its yield curve control policy at its December 20th meeting, widening the tolerance band for its 10-year Japanese government bond (JGB) yield to plus or minus 50bps around a zero percent target, from plus or minus 25bps.

BoJ Governor Kuroda emphasized the change in policy was not a form of monetary tightening, but a move to improve JGB market functioning. However, should the BoJ want to end its negative interest rate policy with a hike of the short rate target, this widening of the 10 year bond yield trading band would help facilitate this by making an exacerbation of yield curve distortion less likely.

On the announcement of the widening of the band, JPY gained approximately 4.7% vs USD. This brought USDJPY into a new, lower trading range of 134.70-129.50 (where it sits today) from 139.85-134.42 earlier in December.

EURUSD, the DXY's largest component, ranged 1.0712-1.0482 over the week, ending it at 1.0646. On Friday, EURUSD rose 1.6% on the disappointing US ISM Services result. Earlier in the week, it was an exciting start to the year, as Croatia became the 20th member of the Euro areaon January 1st. Speaking on December 31st, ECB President Lagarde was hawkish noting that wages are growing and that the ECB must prevent this from adding to already high inflation.

Chart: S&P 500 (inverted), US 10 year yield, DXY Index. The 3 series have been moving together since August, but the USD has separated recently. While movements in the US 10 year yield are still impacting the S&P 500, the DXY Index has been ranging 105.32-103.32 since the start of December (red rectangle).

Chart source: Bloomberg, DS

The Diamond Commodity

DIAMINDX fell 0.4% on the week. Looking at holiday jewelry sales, it is important to note that the US accounts for just over 50% of global diamond jewelry demand. US jewelers were cautiously optimistic heading into the 2022 holiday season. Mastercard SpendingPulse reported that US retail sales ex auto increased 7.6% y/y over the holiday season (November 1 through December 24) as consumers sought a mix of gifts and experiences. Jewelry sales fell 5.4% y/y over the 2022 holiday period, though 2021 saw an outsized gain for jewelry sales of +32% y/y. On average over the past 5 years, DIAMINDX has strengthened in December reflecting holiday jewelry sales, which are made relatively last minute. But in December 2022, DIAMINDX fell 1.1% m/m (table above). This reflects consumer demand for diamond jewelry returning to pre-pandemic levels after solid growth in 2020 and outsized growth in 2021, perhaps less pricing power for dealers as consumers are being squeezed by inflation on other fronts, and a cautious attitude by dealers and consumers about the possibility of a US recession ahead. Seasonally, heading into the new year, DIAMINDX has appreciated in January on average over the past 5 years.

Gold started the year off on a strong note, gaining 2.3% on the week. Gold got a boost on Friday, gaining 2.0% intraday when the US ISM Serves PMI surprised to the downside. In reaction, the USD weakened and gold strengthened exhibiting its safe haven properties as there was some concern among market participants about rising US recession risk as both the ISM Manufacturing and Services Indexes now show contraction. Gold ended the week at USD 1,866.60. For the month of December, gold rose 3.1% m/m, supported by a weaker USD throughout the month (table above).

Silver was mildly lower on the week, falling 0.5% to USD 23.83 - below the key USD 24 level. USD 24.00-24.50 has been a strong area of resistance. However silver finished strong in 2022, gaining 7.9% in December. Similar to gold, silver benefitted from USD weakening, which commenced in late October/early November. Silver outperformed gold, however, sending the gold-to-silver ratio lower to 75.12 in mid-December. The ratio finished the week at 78.32.

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: DIAMINDX, Gold, and Silver Chart source: Bloomberg, DS Sign Up for Market Commentary: Weekly insights on global markets and commodities from Diamond Standard by Amelia Bourdeau

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.
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