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Economic insight: Outlook for the rest of 2019

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      By Vishal Khanduja, CFACalvert Fixed Income Portfolio Manager and Brian S. Ellis, CFACalvert Fixed Income Portfolio Manager

      Boston — Recent data suggest that the U.S. economy lost some of its positive momentum in the first quarter. However, we expect the economy to strengthen in the second quarter and remain on solid ground throughout the rest of the year.

      First-quarter growth is typically weak due to residual seasonality — i.e., the lingering seasonal effects that the Bureau of Economic Analysis (BEA) is not able to remove in the initial seasonal-adjustment process. Over the past 18 years, U.S. GDP growth has averaged just 1.4% in the first quarter, compared to nearly 2.8% in the second quarter, according to BEA data. We also think the government shutdown and severe tightening of financial conditions in late 2018 may have contributed to "noisy" first-quarter readings on consumer sentiment, retail sales and job growth, among other data points.

      Given these dynamics, we believe there is low efficacy in the recent reports, and this might be overstating the weakness in the U.S. economy. In addition, other economic indicators remain strong, particularly with respect to the employment picture. Wage gains continue to outpace headline inflation, and nonfarm payroll growth averaged a robust 180,000 in the first quarter, even with the bad February number. The Job Openings and Labor Turnover Survey (JOLTS) released in March provided further evidence of the positive employment conditions, with job openings exceeding available workers for an 11th straight month in January. Consumer confidence has eased but remains at very high levels, and lower mortgage rates should be supportive of consumer spending and residential housing.

      We believe the U.S. economy will continue to outperform other major developed economies, especially those in Europe. Data coming out of the eurozone remains very weak, which should keep ECB tightening plans on hold for a while and continue to pressure global yields. Brexit remains a huge question mark for the U.K., and the Bank of England has indicated that a chaotic departure might prompt a rate cut. As for the Federal Reserve's future rate path, markets are pricing in close to one cut by year-end. We think these expectations are overly dovish.

      Economic Insight: Outlook for the rest of 2019

      Source: Bloomberg, as of 4/5/19.

      Bond yields have fallen to levels that, in our view, do not reflect the underlying strength of the U.S. economy. As a result, we favor a slightly underweight view on interest-rate duration. We also became less optimistic on Treasury Inflation Protected Securities (TIPS) exposure during the first quarter, as breakevens have recovered from their fourth quarter lows. That said, we continue to favor a strategic allocation to TIPS as a hedge against inflation. We expect inflation to trend higher, in part due to a new inflation-targeting framework the Fed is evaluating. With the strong first-quarter rebound in valuations, we think it makes sense to generally reduce risk in portfolios after favoring opportunistically adding to risk assets at the end of the fourth quarter. More specifically, we are less optimistic on investment-grade and high-yield corporates.

      As we favor dialing back risk, we think short duration bonds and Treasurys make sense. This may help maintain extra liquidity to take advantage of the volatility we expect. We believe the volatility in rates and credit spreads that we have seen over the past few quarters will continue in the months ahead.

      Bottom line: Economic and geopolitical uncertainty remains elevated, yields and risk assets have rallied significantly, and we are in the late stages of the credit cycle. We are therefore cautious on interest-rate and spread duration, and favor an approach based on bottom-up security selection.