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Investment outlook

The Fed shows patience, but moves toward first rate cut

Tony A. Rodriguez
Head of Fixed Income Strategy, Nuveen
The Federal Reserve building

The Fed’s latest economic projections show only one rate cut this year, down from three previously, as officials again hold rates steady before moving to ease policy.

What happened?

The U.S. Federal Reserve kept policy unchanged for the seventh consecutive meeting, as expected. It made small changes to the policy statement, now saying there has been “modest further progress” on inflation, rather than “a lack of further progress.”

The accompanying Summary of Economic Projections showed a shift in rate expectations. The median FOMC member now anticipates only one rate cut this year, down from three previously. The total number of cuts expected through the end of 2026 remained unchanged. That move came alongside an upward revision to the near-term inflation outlook and no change to expectations for growth or employment.

In his press conference, Chair Powell continued to signal that the next move will be a rate cut, and that the timing of the first cut will depend on the incoming data. He indicated that, notwithstanding the better recent data, the FOMC still wants to see further improvements before it can be fully confident that inflation is returning sustainably to the 2% target. Powell also indicated that the Fed is watching downside risks to growth, and unexpected weakening in the labor market could support rate cuts.

Economic momentum begins to soften

The first quarter was dominated by strong labor markets and hot inflation, but conditions have moderated in recent months. We continue to anticipate a further deceleration in growth, which should feed through to lower inflation.

On the inflation front, key metrics have shown slow but steady progress since the hot readings at the start of the year. The most recent core CPI data cooled significantly, to an annualized pace of +2.0%. Shelter inflation is still rising too fast, but signs of deceleration have appeared in other areas of core services, and core goods prices continue to fall.

The labor market remains strong overall, with a healthy pace of job creation of around +250,000 per month and steady wage growth. However, the unemployment rate has ticked higher to 4.0%, and other measures increasingly show loosening. The number of job openings fell further, and the private quits rate remains below pre-Covid levels.

Other metrics have slowed as well. The latest retail sales data showed flat spending and indicated contraction when excluding volatile elements like gasoline. First quarter GDP was revised down -0.3pp from the preliminary print to an annualized rate of +1.3% quarter-over-quarter.

Looking ahead, we continue to anticipate a modest slowdown in U.S. and global growth this year. Loosening labor markets and softer wage inflation should eventually translate into further deceleration in price inflation. The path will likely remain uneven, and we still expect core inflation to hold well above the Fed’s 2% target into 2025.

What does this mean for investors?

Even as the Fed moves closer to cutting rates, U.S. bond yields remain near their highest levels of the past 17 years. In our view, today’s elevated yields offer an attractive entry point for municipal bonds. U.S. investors in the highest tax brackets may realize taxable-equivalent yields ranging from 5.65% to 6.70% (depending on the maturity), with even higher levels in states with income taxes.

In the below-investment grade space, high yield municipals are yielding 5.6%, for a 9.5% taxable-equivalent yield. About 75% of the high yield municipal bond index is made up of higher-quality BB rated issues. Default rates for these BB rated munis roughly equal those of BBB rated corporates.

In other areas of fixed income, we see opportunities in select asset-backed securities (ABS) and below-investment grade corporates. Within ABS, consumer and commercial credit performance continues to show signs of stabilizing. Default rates are in line with pre-pandemic levels, with substantially higher yields. Commercial mortgage-backed securities (CMBS) offer substantial reward potential for investors willing to accept the risks facing office and retail properties. One area of interest is the private label CMBS market (where loans in securitized pools are not guaranteed by a government agency or government-sponsored enterprise), which has returned more than 5% year-to-date, making it one of the best-performing fixed income sectors. That said, active management is crucial due to the sector’s idiosyncratic risks.

In the below-investment grade space, floating rate senior loans have returned 4.2% year-to-date, with yields ranging from 7.5%-9.5% (depending on quality). Senior loans offer equity-like potential returns with lower volatility and downside risk. The asset class is well positioned to complement the longer duration nature of the broader fixed income landscape. We generally favor up-in-quality loans, but we also consider select opportunities in lower-quality issues.

In equities, U.S. small caps remain attractively valued relative to large caps, with the forward price-to-earnings (P/E) ratio of the Russell 2000 Index versus the Russell 1000 Index near a 22-year low. Additionally, based on analyst estimates, earnings should grow faster for smaller companies in 2024. This is especially salient because corporate earnings growth has been the primary driver of stock price appreciation over the long run — a trend that should continue as inflation and interest rates gradually normalize.

Publicly listed real estate securities such as real estate investment trusts (REITs) were among the hardest-hit asset classes during this Fed tightening cycle that began in March 2022. Given their elevated use of debt compared to broader equities, REITs declined precipitously (-21%) between mid-April 2022 and the end of October 2023, as measured by the FTSE Nareit All Equity REIT Index. But REITs have historically delivered strong relative returns in steady and declining rate environments.

During the final two months of 2023, with the Fed on pause and market expectations for rate cuts peaking, REITs returned +22%. Meanwhile, despite stable REIT fundamentals and generally favorable valuations, investor allocations to real estate are at the lowest level since the 2008 global financial crisis, according to a recent Bank of America survey of global fund managers. The scope of this underweight could be a potential contrarian signal to add incrementally to this sector.

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Federal Reserve Statement, June 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 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.

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