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Investment outlook

The Fed’s latest trim

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

After cutting rates 50 basis points in September, the U.S. Federal Reserve continued trimming with a 25 basis point cut in November.

What happened?

The Federal Reserve cut interest rates by 25 basis points (bps) at today’s meeting, as expected. The policy statement had only modest changes, and we continue to expect another 25 bps cut at the next meeting in December.

The policy statement said “labor market conditions have eased,” a slight change from the prior version which stated “job gains have slowed.” That tweak reflects the last two jobs reports, which show a slowing trend, but not as weak as earlier in the year.

In his press conference, Chair Powell reiterated that policy is “not on a pre-set course,” and the Fed will make upcoming policy decisions on a meeting-by-meeting basis. When asked about the impact of the election on monetary policy, he said that at this point, “the election will have no effect on our policy.” Powell went on to say that the Fed will respond as needed to changes in fiscal policy – whether that requires higher or lower policy rates – but only once those fiscal changes are clear.

Economic data continue to show disinflation and a modest slowdown

Economic data have strengthened our expectations for a soft landing for the U.S. economy. Growth remains healthy and inflation is moderating, even as labor markets loosen. We expect those trends to continue over the coming quarters.

Employment data have been mixed, though the latest readings point to a further slowdown. The October jobs report disappointed versus consensus expectations with only +12,000 jobs created, and it included another -112,000 downward revision to the prior two months’ numbers. The unemployment rate ticked higher again after falling in the prior two months. This less-rosy trend aligns with signals from other labor market data, including a recent decline in the number of job openings, a drop in the private quits rate, and a very small but noticeable increase in the layoff rate.

Recent inflation readings have mostly been encouraging. In particular, housing inflation slowed in the third quarter to an annualized pace of +4.8%, down from +5.1% in the first half of the year and +6.3% in 2023. At the same time, wage inflation has cooled materially, with a broad measure of labor costs dropping to its slowest rate in over three years.

Despite the slower labor market, consumer spending remains robust. Overall spending, while slower than last year’s strong pace overall, has accelerated in the third. That propelled third quarter GDP growth to an annualized pace of +2.8%, more than offsetting a drag from inventories and residential investment. Heading into Q4, the consumer shows no signs of slowing down, which will likely continue to support growth.

Looking ahead, we continue to expect labor markets to slacken further and inflation to return to target toward the end of next year. Overall economic growth is likely to slow as well, to around 2% by the middle of next year.

What does this mean for investors?

We see ample opportunities for investors to deploy capital, given our expectations for the U.S. economy to continue steadily slowing and for the Fed to respond with gradual rate cuts. In particular, we see compelling cases for certain plus sectors in fixed income, some non-U.S. equity markets, and, for the first time in the cycle, real estate.

Preferred securities, an investment grade asset class, is among the top-performing fixed income sectors year-to-date, with a total return of +10.6% through 31 October (as measured by the ICE BofA All Capital Securities Index). This impressive gain has been driven by compelling yields, favorable supply/demand dynamics and strong bank earnings.

Among the different types of preferreds, we favor $1000 par securities, which are yielding 5.95% with a spread of 177 bps over U.S. Treasuries. Banks, the largest issuer of preferred securities, have generally beaten consensus earnings estimates this reporting season. Earlier this year, annual stress test results demonstrated the continued strength of bank balance sheets with robust capital ratios.

Meanwhile, in securitized assets we see opportunities in both commercial mortgage-backed (CMBS) and asset-backed securities (ABS). In particular, we like segments that are not part of the Aggregate Bond Index. Looking at these less-liquid sectors can widen the opportunity set, creating the potential for additional returns. Among securities included in the Agg, CMBS has returned +4.3% year-to-date, and ABS +4.3% — certainly strong gains. But the broader, out-of-benchmark CMBS and ABS categories, as measured by ICE BofA indexes, are up even more, returning +9.9% and +6.5%, respectively, year-to-date.

Spreads in the broader CMBS and ABS universe are wider than those of other investment grade sectors. As a result, they offer the potential for continued strong performance while providing investors with substantially elevated yields. 
Within CMBS, we’re finding opportunities in the private-label market. These single asset, single borrower deals derive their cash flows solely from one multifamily building (in a desirable geographic area). This allows managers with strong credit research teams to perform the necessary due diligence on these transactions.

On the ABS side, we see opportunities in esoteric securities backed by nontraditional assets. These deal sizes are usually smaller, but they typically provide an additional 75 bps to 125 bps in yield compared to short-maturity corporate bonds. We prefer commercial ABS exposure in areas like fiber optic cable lines, data centers and cell towers.

In equity markets, we increasingly see potential in certain regions within the non-U.S. space. Through mid-October, global equities are up over +16% this year, based on the MSCI All Country World Index (ACWI). While that’s an impressive gain, it has led to stretched valuations: The ACWI’s forward price-to-earnings ratio (P/E) sits at 18.1x, well above its 14.6x average since 2006. The high price tag on equities in many regions makes us especially mindful of where to actively add exposure.

Two markets we find interesting in the current environment are Japan and China. Both offer attractive valuations and a higher dividend yield relative to the ACWI. In Japan, the recent election of Shigeru Ishiba as prime minister surprised markets, leading to a moderate selloff that we believe has been overdone. Equity markets in China have been quite volatile this year, which we expect to continue. However, Chinese stocks are trading at a forward P/E of 10.8x, below their long-term average of 11.4x. If government stimulus succeeds in sparking domestic growth, earnings per share could be revised upward as well, further benefiting Chinese equities.

Finally, after seven consecutive quarters of negative total returns, the private real estate sector, as measured by the NCREIF ODCE Total Return Index, was up +0.25% in the third quarter of 2024. The extended downturn for real estate had been triggered by the Fed’s aggressive 2022-2023 rate hiking cycle and post-pandemic stress in the office property sector. Now, however, with the Fed initiating its easing cycle and projecting further rate cuts over the next two years, the interest rate environment should become a tailwind. We believe both stabilizing fundamentals and transaction market pricing point to a broad recovery.

A pullback in new construction activity across property types should bode well in the medium term, helping to moderate supply, a positive for rent growth. In the U.S. apartment and industrial markets, new construction starts are at less than one-third of their peak levels across apartment and industrial markets. Meanwhile, the volume of square footage currently under construction has returned to pre-pandemic levels.

In our view, the private real estate market correction is nearly complete — and now could be a good time for investors to take a fresh look at the asset class.

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Endnotes

Sources
Federal Reserve Statement, November 2024.
Bloomberg, L.P.

This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.

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. 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.

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. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure and therefore are subject to greater credit risk. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. Asset-backed and mortgage-backed securities are subject to additional risks such as prepayment risk, liquidity risk, default risk and adverse economic developments. The value of convertible securities may decline in response to such factors as rising interest rates and fluctuations in the market price of the underlying securities. Senior loans are subject to loan settlement risk due to the lack of established settlement standards or remedies for failure to settle. These investments are subject to credit risk and potentially limited liquidity, as well as interest rate risk, currency risk, prepayment and extension risk, and inflation risk.

Investors should contact a tax advisor regarding the suitability of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. Taxable-equivalent yields are based on the highest individual marginal federal tax rate of 37%, plus the 3.8% Medicare tax on investment income. Individual tax rates may vary.

Nuveen, LLC provides investment solutions through its investment specialists.

This information does not constitute investment research as defined under MiFiD.

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