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Facing heightened uncertainty, the Fed delivers another hike
The U.S. Federal Reserve hiked rates, as expected, at today’s policy meeting. Uncertainty has increased since the last meeting. Though we expect at least one more hike this year, the Fed appears – for the first time this cycle – to be nearing the end of tightening.
The U.S. Federal Reserve continued its tightening cycle by hiking rates another 25 basis points (bps). That takes the target range for the policy rate to 4.75% - 5.00%, a fresh 16-year high.
Despite that hawkish headline, the rest of the meeting leaned significantly in the opposite, dovish direction. The policy statement now says that “some additional policy firming” will be needed, rather than the prior reference to “ongoing increases” in the policy rate. Notably, the Fed also used that language in 2006 to signal an impending pause in its rate hiking cycle.
Separately, there were no major changes to its macroeconomic projections. The median forecast is now for slightly higher inflation and slightly lower growth this year, but the terminal interest rate of 5.1% remains unchanged.
In his press conference, Chair Powell explained that he expects additional tightening will be needed. It remains to be seen if that tightening will come from higher policy rates or slower bank lending as a side-effect of the recent financial stress. Either way, the committee still sees lowering inflation as its principal near-term goal.
Banking stress balanced by growth and inflation
Since the Fed last met, markets have been hit by various gusts of bad news. Several U.S. banks failed, including the 16th-largest by deposits, and the ramifications remain uncertain. Contagion risks look low for now, thanks to the quick and forceful reaction from policymakers. Nevertheless, equities and other risk assets across the spectrum have weakened, giving back much of their rallies from earlier in January.
Despite the storm clouds hovering over the financial system, the latest economic data indicate nothing but clear skies. The labor market continues to create jobs at a blistering pace and surveys suggest improving sentiment. Income growth is strong as well, which should support future spending.
In fact, before the recent financial stresses, the principal risk was that the economic weather would remain too sunny for too long. Inflation continues to run hot, which, along with upward revisions to the 2022 figures, indicates that the inflationary trend has not substantively moderated in recent months.
The economic and policy outlook remains highly uncertain in the current environment. We expect the U.S. financial system will avoid a deeper crisis, but lending conditions should tighten further. With inflation remaining a problem for the Fed, we expect at least one more rate hike later this year. These factors should combine to weigh further on growth in the quarters ahead. Though we do not see a hurricane on the horizon, 2023 will likely continue to see periodic squalls. Investors would be wise to pack an umbrella.
What's going to work for investors?
Given the complicated economic and market backdrop, we don’t expect a smooth ride, as several risks still loom large. While the interest rate outlook remains uncertain, the environment of ultra-low rates is clearly behind us. Inflation remains elevated. And we expect the global economy will slow.
We still think it makes sense to be selective with cyclicality and focus on quality across diversified portfolios. We emphasize dividend-paying equities as well as infrastructure investments that can weather a combination of slowing economic growth and volatile interest rates. Additionally, we like relatively higher quality areas across fixed income spread sectors.
Now may be a good time to consider taking profits in some areas and adding to risk in others. Many public market valuations have shifted noticeably so far this year. We continue to believe that investment grade fixed income, public REITs and investment grade municipal bonds offer compelling fundamentals, but all three have enjoyed strong rallies that have made valuations less compelling than they were at the start of the year. We also see opportunities to add some risk and beta to portfolios by focusing on emerging markets (particularly emerging markets equities). Additionally, we continue to like high yield municipals.
Federal Reserve Statement, March 2023.
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Important information on risk
This report is for informational and educational purposes only and is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice or analysis. The analysis contained herein is based on the data available at the time of publication and the opinions of Nuveen Research.
The report should not be regarded by the recipients as a substitute for the exercise of their own judgment. All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. It is important to review investment objectives, risk tolerance, tax liability and liquidity needs before choosing an investment style or manager.
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk, and income risk. As interest rates rise, bond prices fall. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity, and differing legal and accounting standards. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. Real estate investments are subject to various risks, including fluctuations in property values, higher expenses or lower income than expected, and potential environmental problems and liability. Please consider all risks carefully prior to investing in any particular strategy. A portfolio’s concentration in the real estate sector makes it subject to greater risk and volatility than other portfolios that are more diversified and its value may be substantially affected by economic events in the real estate industry
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