US could avoid recession, rates to push above 5pc: Nuveen’s Brian Nick

The global investment manager says a soft landing is still on the cards, warns of challenges ahead for equity markets.

Brian Nick, chief investment strategist of global investment manager Nuveen sees US rates peaking above 5 per cent next year.

The US economy could escape a recession next year, with the prospect of a soft landing on the cards even with the Federal Reserve likely to keep rates higher for longer, according to global investment manager Nuveen.

But the headwinds that pelted investors in 2022 – inflation, rising yields, hawkish central banks and a rocky geopolitical landscape – will see volatility and uncertainty continue, at least for the first part of 2023, US-based Nuveen, one of the largest investment managers in the world, has warned.

As the US central bank prepares to lift the Federal Funds rate yet again in the coming days, its seventh hike in a row, Nuveen chief investment strategist Brian Nick believes the market has it wrong on the terminal rate outlook.

“I think where the Fed is going to end up is somewhere north of what‘s currently priced in. At this point it seems like they’re most concerned about taking their foot off the brake too early. Yes, they’re going to decelerate in December to 50 basis points, but I think the messaging is going to be quite hawkish,” Mr Nick said.

“Markets are not going to like (this week’s) meeting, because I think the Fed is going to deliver on basis points but they‘re also going to promise, probably, a much higher terminal rate next year than what the markets are looking for.”

That terminal rate – the peak at where the benchmark interest rate lands – will end up being above 5 per cent, likely around 5.25 per cent, and will remain at that level until 2024, he predicted. (The market is currently pricing in a terminal rate of 4.9 per cent.)

Inflation, meanwhile, will ease to a degree in the first half of next year but the outlook is murkier for the second half, according to Mr Nick.

“Most of the steep decline in inflation that we’re going to see on a year-on-year basis will be in the first and second quarter of next year. After that’s it‘s going to be a question of how much further we can get core inflation down. Is the economy slowing down enough? Is consumer demand slowing down enough? Is the labour market softening, so we see unemployment going to four, four and a half, maybe 5 per cent?

“That’s consistent with a mild-ish recession and I would think that you’re going to have core inflation pretty close to target by the end of next year.”

He hasn’t yet ruled out a soft landing, though, as long as unemployment remains below 4.5 per cent.

On the earnings front, and the challenges for investors, he doesn’t see a severe earnings recession coming through, but is not expecting to see earnings growth next year either.

What this means for investors is that defensives are the most attractive option right now, the investment strategist said.

“We’re going to be pretty defensive in terms of our favourite place to be in the equity market. (We like) REITs – they’ve gotten really beaten up this year …(we’ll be in) defensive growers, dividend growers. Healthcare is another area that we like, it represents the intersection of those two things.

“But we’re not swinging for the fences next year with equity returns.”

Nuveen, the investment arm of financial services giant TIAA, expects to see US equity market returns of 5 to 7 per cent over 2023, assuming the recovery from rate hikes gets under way around mid-year.

“The pain point for the economy and for the markets is going to be in the first half of the year, which gives me hope and an expectation that there’s enough runway left over the balance of the year that stocks will find a footing and start to kind of rebuild,” Mr Nick said.

“But that assumes that most of the earnings damage is done and that we generally have it right in terms of what‘s going to happen to profits and margins by spring.”

With equities set for a challenging period ahead, the investment manager is favouring fixed income over stocks for the timebeing.

“Stockmarkets globally are down about 20 per cent this year. Typically that‘s a time when you want to be buying, but this is arguably the first bear market we’ve ever seen where stocks have actually gotten more expensive against most other assets because the rate on cash and bonds have gone up so much.

“The spread you can get on a corporate bond or even a higher yield bond is much more attractive in what is going to be a slower growth environment and one where earnings growth is not particularly robust. Our overall defensive (stance) is not just limited to intra-equity markets but across asset classes.”