Insights.
What can the diamond industry expect when the Federal Reserve raises interest rates for the first time in seven years? Or, more pointedly, will a rate hike put a dent in discretionary spending?With the Fed widely expected to increase rates next week, diamantaires ought to consider if external economic factors will exacerbate a crisis largely stemming from industry-specific issues by putting consumer demand for diamonds under pressure.
At a Congressional hearing last week, Fed Chairwoman Janet Yellen appeared confident the economy can withstand the first step toward interest-rate normalization as steady growth is being sustained and inflation is likely to pull back toward its 2 percent target level. “The U.S. economy has recovered substantially since the Great Recession,” she said.
Yellen noted real gross domestic product (GDP) has risen at a moderate pace as the labor market improved, while private purchases – household spending, business fixed investment and residential investment – have outpaced real GDP growth this year.
“Job growth has bolstered household income, and lower energy prices have left consumers with more to spend,” Yellen said at the hearing on December 3. “Increases in home values and stock-market prices in recent years, along with reductions in debt, have pushed up the net worth of households, which also supports consumer spending.” Her position was vindicated the next day when the Labor Department reported employers added 211,000 jobs in November, beating analyst expectations in market surveys.
Yellen disagreed with Congresses’ concern that a slower wage growth, stronger dollar and the recent terror attacks in the U.S. would destabilize the economic recovery suggesting that a continuation of the Fed’s easy monetary policy is appropriate. As expected, her hawkish comments fueled long-standing speculation the Fed will raise rates at its next policy meeting on December 15-16.
Measured approach
For many, the Fed fund rate has been left too low for too long and a change in trajectory is inevitable. Importantly, the U.S. central bank is expected to adopt a measured approach as analysts at Nomura Global Markets Research forecast a second increase in rates is unlikely before June. It seems the Fed wants to allow initial 2016 economic data to sink in before deciding on further hikes as a policy reversal after starting the normalization process would greatly undermine its credibility. The initial rate increase will probably be small, with some saying it could be as low as 10 basis points, as the Fed would like to err on the side of caution.
Regardless, the diamond and jewelry companies should take it as a message to stay on a conservative path. At least, being over-financed at this stage of the interest-rate cycle would not be considered prudent. As banks cut lending to the industry in 2014/15, excessive borrowing – at least in the West – is probably not a major concern.
