Bottom line up top

• The devil, or in some cases the angel, is in the details. On Wednesday the economic calendar brings the April CPI inflation report, the fourth major macro metric in a span of just 10 business days. We’ve already seen a surprise negative GDP print, a much-anticipated Fed rate hike and a monthly payrolls report that — while broadly in line with expectations — contained some underlying inconsistencies. All four have significant and potentially market-moving implications for the economy. Interpreting them can require discerning whether the underlying specifics are as “bad” or “good” as the headline number suggests. 

1. GDP: more than meets the eye. The government’s recent -1.4% advance estimate for 1Q growth masked a considerably better-performing economic engine under the hood. In particular, final sales to private domestic purchasers — in our view, a more reliable indicator of domestic demand than headline GDP — grew at a 3.7% annualized rate. We continue to believe that, barring an unforeseen exogenous shock, a U.S. recession is not in the cards for 2022.
2. Fed meeting: few surprises but big reactions. As expected, the Fed raised the target federal funds rate by 50 basis points and announced it would begin reducing its $9 trillion balance sheet in June — a hawkish two-pronged strategy to normalize monetary policy quickly. Chair Jerome Powell downplayed talk of any 75-basis-point hikes, helping fuel a massive post-meeting relief rally in equities. Those gains and more were erased in the following day’s market meltdown, as investors suddenly turned bearish in advance of Friday’s jobs report and this week’s CPI print. The sharp reversal suggests that investors may have priced in all the Fed tightening we’re likely to see for now, but they haven’t priced in increased odds of a recession.
3. Employment still robust: The April jobs report, in our opinion, has some inconsistencies. Employment increased beyond expectations, however, the unemployment rate remained flat due to a drop in the labor force participation rate. Despite the tighter labor forc picture, the average hourly earnings slightly softened. The establishment survey, which looks at private nonfarm businesses, signaled strength while the household survey indicated a pullback in employment.
4. What’s up with inflation? April CPI data could help confirm whether we’re correct in our view that inflation is nearing its peak. As always, the devil will be in the details. Energy prices will likely remain an outsized driver of inflation. As such, we will pay close attention to core CPI, which excludes food and energy inflation. We would note that the core PCE price index, the Fed’s preferred inflation barometer, did not accelerate in March and actually was revised lower for February.

“Evidence that monetary tightening is starting to work its way through the system could be a welcome harbinger of cooler inflation”

Portfolio implications

Our economic base case remains intact, but market volatility should persist. Nuveen’s Global Investment Committee continues to believe a recession isn’t imminent, given a historically tight labor market with nearly two job openings for every unemployed person and aggregate income growth running well above inflation (Figure 1). Despite the healthy labor picture, markets are rapidly repricing to account for the odds of lower economic growth, more persistent inflation and tighter monetary conditions. Until any of these three dynamics changes, investors should expect continued market swings in both stocks and longer-duration bonds.

Tight makes right — or at least it might. Evidence that monetary tightening is starting to work its way through the system could be a welcome harbinger of cooler inflation. For example, skyrocketing 30-year mortgage rates may be slowing housing demand, as mortgage applications for new-home purchases have fallen to pre-pandemic levels (Figure 2). And the ISM New Orders Index has returned to early 2019 levels, a potential sign of slower inventory building in anticipation of less consumer spending. Employment is important, but housing and new orders are important as leading indicators of overall economic activity.

Where and how to allocate assets. If we’re correct that growth will decelerate but the economy will avoid a recession, how should investors position their portfolios?

• As we discussed in last week’s commentary, fixed income investors targeting the belly of the duration curve are benefiting from the highest starting yields in years. And while strong fundamentals support the broad case for corporate credit, maintaining a higher-quality bias within high yield bonds and loans is prudent in this environment. We also believe tax-sensitive investors should continue taking advantage of dislocations in the municipal market.
• Within equities, our preference for defensive exposure is dividend growers. Companies with strong balance sheets and the ability to grow dividends can be especially attractive in an inflationary environment. 

Both equity and fixed income markets have had tremendously difficult year to date, to put it mildly. Unfortunately, occasional periods of pain are inevitable in the pursuit of long-term investment returns. We will continue to evaluate the data cautiously across our portfolios and keep our clients informed about where we are finding opportunities.

“Companies with strong balance sheets and the ability to grow dividends can be especially attractive in an inflationary environment.”

Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.

Regular meetings of the GIC lead to published outlooks that offer:

• macro and asset class views that gain consensus among our investors
• insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
• guidance on how to turn our insights into action via regular commentary and communications