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Investment outlook

The Fed inches closer to cuts

Tony A. Rodriguez
Head of Fixed Income Strategy, Nuveen
A closeup of the eagle on a dollar bill.

The U.S. Federal Reserve left interest rates unchanged at its January meeting, as expected, but continued to signal that rate cuts will begin this year.

What happened?

The U.S. Federal Reserve kept interest rates at 5.25% - 5.50%, remaining at their 22-year high. Despite the lack of updated economic projections at this meeting, the policy statement contained substantial revisions, which leaned hawkish overall.

The policy statement removed the reference to “additional policy firming that may be appropriate,” which had kept the door open to additional rate hikes. The statement now reflects the move toward rate cuts this year, though it said that the FOMC does “not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%.” Separately, the statement also added a new reference to both halves of the mandate, inflation and unemployment, “moving into better balance.”

In his press conference, Chair Powell explicitly said that a cut at the next meeting in March is “not the most likely case.” He reiterated that the committee needs more confidence and wants to see more evidence that inflation is truly on a path to the 2% target.

Overall, today’s meeting remains consistent with rate cuts this year as inflation moderates and downside risks to growth increase. However, the market-implied odds of a cut by March, which had reached as high as 78% before the meeting, are now down to around 37%. We continue to expect rate cuts to start closer to midyear. 

Recent data has supported a soft landing

The most important development since the last meeting has been the continued, surprisingly robust progress on disinflation. Core PCE inflation ended 2023 at +2.9% year-over-year, notably lower than the Fed’s projection from earlier in December (+3.2%) and significantly lower than its projection from last June (+3.9%). There has been continued progress in all the key areas, including housing, core services and durable goods, though the former two categories remain uncomfortably high.

One reason for optimism that inflation will continue to moderate moving forward is the steady softening in wage pressure. Actual wage inflation has slowed, and leading indicators point to further decelerations ahead. The private quits rate is down, the number of job openings is lower, the pace of job creation has slowed, and cyclical measures of employment have moderated.

As a result of the slowdown in the labor market, downside risks to growth have picked up. Fourth quarter U.S. GDP growth remained very strong at +3.3%, but that headline number was boosted by temporary effects from inventories and net exports. Meanwhile, growth in China decelerated and flatlined in Europe. Measures of current activity in both economies remain very weak.

Looking ahead, we anticipate a further gentle slowdown in global growth and progress on disinflation. The unemployment rate is likely to tick (but not spike) higher over the course of the year. 

What does this mean for investors?

With the Fed pivoting more fully away from rate hikes and toward rate cuts, investors need to pivot as well. Though fixed income and equity markets have both rallied substantially over the last three months, there are still many areas of opportunity.

We encourage investors to assess their taxable fixed income portfolio allocations and consider opportunities we see across the asset class. Our outlook calls for the 10-year U.S. Treasury yield to fall from current levels to finish 2024 around 3.50%. Accordingly, we think extending duration in fixed income portfolios could be wise.

There are opportunities in investment grade corporates, securitized products, preferreds and high-quality areas within high yield and senior loans. In municipal markets, AAA rated bonds currently yield more than U.S. Treasuries on a taxable-equivalent basis. There is also compelling value in lower-quality investment grade (BBB) munis, which are yielding substantially more than their AAA muni counterparts across short- and long-term maturities.

In equities, we recommend avoiding more cyclical exposures in favor of defensive, less economically sensitive areas. Dividend growers are supported by positive fundamentals, sustainable growth potential and ample free cash flow. Information technology remains popular, and we prefer tech areas that are less consumer centric, like software. Health care has defensive attributes that we find attractive in the current environment, especially managed care and health care distributors.

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Federal Reserve Statement, January 2024.
Bloomberg, L.P.

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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.

Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. A focus on dividend-paying securities presents the risks of greater exposure to certain economic sectors rather than the broad equity market, sector or concentration risk. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. 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. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Concentration in infrastructure-related securities involves sector risk and concentration risk, particularly greater exposure to adverse economic, regulatory, political, legal, liquidity, and tax risks associated with MLPs and REITs.

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