In September, the Fed hiked interest rates by 0.75% in a bid to combat rising inflation and drag it back down to 2%.
This year has seen rates increase by 3% overall; currently sat at 3.25%, it seems, for now, the only way will continue to be up – the FOMC’s median projection suggested that 4.4% would be an appropriate rate at the end of this year.
“The FOMC is strongly resolved to bring inflation down to 2% and we will keep at it until the job is done,” Powell told a Press conference.
Two conditions will need to be met for inflation to normalize, according to Powell. These are achieving a period of growth below trend, and a softening in labour market conditions that sees a “better balance” struck between supply and demand.
“In light of the high inflation we’re seeing, and in light of [what’s still required], we think that we’ll need to bring our funds rate to a restrictive level and to keep it there for some time,” Powell said.
The Dow Jones Industrial Average, S&P 500, and NASDAQ Composite all closed between 1.7% and 1.8% following the announcement.
Had the FOMC become “spooked” and increased rates by a full percentage point, Conning global chief investment strategist Rich Sega told Insurance Business that this could have been “very negative” for near term economic growth.
Some analysts had predicted that the Fed could have gone for a lower 0.5% rise.
“If they were reading the actual inflation numbers that have rolled over [from] a couple of months ago, and backed off to a 50-basis point hike, it would have been fairly positive for the next quarter or so for growth,” Sega said.
As it was, the rate hike fell “right down the middle of recent expectations”, Sega said.
In Sega’s view, the 0.75% rise put the US in a likely position for a “relatively mild” recession into the fourth quarter – though the risk is “not nearly as bad” as if rates had been increased by 1% or more.
“If we have a lower increase in rates, we might have been able to put it off a little more or maybe avoid it entirely,” Sega said.
“But as it happens, I think the odds are for [the declaration of a] recession some point soon, next quarter, most likely.”
Low growth, Sega said, is “particularly” bad for the insurance industry.
“Bond values are holding up if rates go low, but yields – which insurance businesses thrive on – are down and they’re likely to stay down if growth falters,” Sega commented.
“I feel like the insurance industry will thrive on things like household formation – the housing market is slowing in concert with the raising of rates, that’s not good for insurance; household formation is huge for insurance demand for both life and property and casualty,” Sega said.
“I like to see more of that, not less, for our industry.”
In terms of insurance investments, there has already been a “branching out” since the Great Recession of 2007 to 2009, with a move from traditional high quality bond portfolios to other kinds of bonds, structured products, with interest in high dividend equities and the private markets. In some jurisdictions, there has been a move towards derivatives.
“I think if rates stay low, then that’s the kind of pressure that will still be there – pressure on insurance earnings, because yields are low, and some of the higher rates seen in longer issue portfolios have been rolling off and not replaced by enough yield to be able to hold the portfolio up,” Sega said.
Rising interest rates have posed a problem for re/insurers on a global scale where it comes to investment returns, with a selection of large reinsurers analysed by DBRS Morningstar having performed “significantly worse” in the first half of 2022 year on year, despite strong underwriting performance.
Unrealized losses were spurred by “mark-to-market declines in equities and bond valuations”, DBRS updated.
Five of the 10 largest reinsurers tracked by the ratings agency saw net investment losses for the half, with PartnerRe reporting the largest loss at $1.5 billion.
Other reinsurers in the cohort to report net investment losses included TransRe ($217 million), AXIS Capital Holdings ($84 million), Arch Capital Group ($372 million), and MAPFRE Re ($2 million).