Key economic indicators that matter now – and in the future

Marcus Winter (00:02):

Hello, and welcome to Nothing Assumed, a quick talk on topics that keep the reinsurance industry up at night. My name is Marcus Winter and today it is my pleasure to welcome my colleague Oliver Buesse as my guest. Oliver is head of Munich Re's Economic Research Unit in Munich, Germany and together we will chat about the current state of the global and US economy, its impact on our industry and what risks we should be tracking for the future. Oliver, welcome and thanks for joining me.

Oliver Buesse (00:34):

Thank you, Marcus. It's a pleasure to be here.

Marcus Winter (00:36):

Oliver, can you kindly provide a synopsis of where we stand in terms of the global economy?

Oliver Buesse (00:42):

Yes, sure. I think it's good to start with a background here. I think we need to remind ourselves that we had two major crisis in just three years. In 2020 there was a pandemic, the massive global recession. And in 2022 there was the war in Ukraine, which induced a very strong energy market crisis, especially in Europe but also globally, and it affected the US as well. So the world economy was kind of a difficult situation already in 2022, strong COVID-19 recession recovery that came to an end and lots of headwinds from inflation, rising interest rates, zero COVID policy in China, and that's created weak starting point for this year. And so broadly speaking, we are expecting segmentation in both the US and in Europe. We don't expect a recession and that's a risk scenario only. So against this backdrop of slow growth and high inflation, central bank policy will remain important this year.

(01:43):

Monetary policy is trying to bring inflation back down to the target. We think it can work, but we are not sure if it'll be possible without stoking a recession. And there's another important question that came up recently and that's how financial markets will digest huge increase in interest rates. The insolvency of Silicon Valley Bank and the increase in financial market stress I think have made really clear that that's an important question also affecting monetary policy and central banks. As I mentioned, the war in Ukraine made brutally clear that geopolitical risk factors are very relevant and we think they will continue to play a role for the outlook for 2023 and beyond, the war in Ukraine, then China, US relations, then the Middle East region. So all of this creates downside potential for this outlook. There's a little bit of upside as well, but overall we think there's more downside risks than there's upside potential to the outlook.

Marcus Winter (02:50):

Those are many different and challenging factors for the global economy. Now let's move on to the US economy. What are some of the key economic indicators we should be tracking?

Oliver Buesse (03:02):

Yes, I mean as an economist I would talk about economic growth first. I mentioned we will see stagnation or slow growth in the US as well. Where does it come from? It comes from high inflation, it affects disposable income, it affects spending power of US households. We had already increased interest rates which act as a drag on investment spending. And we have US companies that are running down the large stock of inventories. So overall, that's not an argument for strong growth, but against all these headwinds, the US economy is quite resilient, even more resilient than we thought just a couple of months ago. And that's related to the labor market. We still have pretty strong jobs reports from the Bureau of Labor Statistics. Employment growth is solid and as long as this continues, the US economy will very likely be able to prevent falling into recession.

(04:01):

Of course, there are more risk in these days, especially those related to financial market conditions. The US economy seems resilient. That has implications for the inflation outlook and also for the monetary policy by the US Fed. First of all, consumer price inflation is going down if measured very broadly. And this should continue. And of course there's more uncertainty regarding the inflation outlook given these circumstances and this will also affect monetary policy. But I think it's important to note that the Fed seems pretty determined to bring inflation back to target again.

Marcus Winter (04:38):

And do you see direct implications for the US insurance and reinsurance companies?

Oliver Buesse (04:43):

Yes, I think there are a couple of ones. First of all, weak economic growth means not much support in terms of new business opportunities for the insurance industry. If you think about nominal premium growth, this will be pretty robust in our view because we have the inflation in facts. And then of course inflation will remain a topic for the industry. As I said, we expect it to go down, but uncertainty to remain high. And we should also keep in mind that inflation effects can be quite different across different parts of the economy. And CPI inflation's not the only relevant driver of claims inflation for the insurance industry. Then we have financial market effects, higher bond yields of course are positive for investment income, but if you think about more volatility in financial markets, which could stay with us for a couple of time makes it more difficult on the investment side. And finally, if you think beyond 2023, and that's especially relevant for long tail business, there is potential for sustained higher than expected wage inflation because as I said, labor markets in the United States are pretty resilient.

Marcus Winter (05:54):

Of course. I fully understand that there's a lot of uncertainty related to this outlook, but can you talk about inflation in particular, what that means for the central bank policies and how the recent financial market turmoil is affecting this outlook?

Oliver Buesse (06:09):

Sure. These are very important topics. I think regarding inflation, there are two key uncertainties. The first is to what level will inflation decline? And the second is how quickly will it go down? Both affect the outlook for this year and the years to come. Overall, it's very important to understand different trends within the inflation development. The first is we have a strong disinflationary trend coming from energy prices, we’ve also strong disinflationary trend coming from goods prices. So there's a strong force that’s driving inflation down. On the other hand, regarding services inflation and this includes housing inflation, it's still increasing and that makes inflation sticky and that makes the outlook difficult. And there are two components here. Talking about housing inflation, it's pretty easy to assume that this will turn down because it's related to home price growth with a huge time lag and as home price growth is declining these days given increased mortgage rates, it's very likely that shelter inflation will turn down again quite mechanically.

(07:14):

The more difficult part is the other parts of the services industry and this pretty much relates to labor markets. As long as labor markets remain strong, as long as wage growth is there, it's difficult for the services sector to keep up with cost push from labor markets. And as long as this continues, we will see elevated levels of services inflation and that will take time to go down and only if it does [inaudible 00:07:42] we can be sure that the inflation target of the Central Bank is possible to be reached.

Marcus Winter (07:47):

That certainly doesn't make the job for the Fed any easier, does it?

Oliver Buesse (07:53):

No, it's a difficult situation. In order to bring inflation down, the labor markets needs to be less robust. We need to see lower employment growth, softer wage growth. But as I said, it's a two-handed situation. First of all, robust labor market helps the US economy. But secondly, on the other side, it's also difficult regarding monetary policy because strong labor markets will hinder the decline in inflation. And there's another difficulty for the Fed and that it's a huge uncertainty how long it will take until the unprecedented speed with which interest rates have increased last year and going to this year will be felt in the economy. There's no historical evidence, so the Fed just don't know how strong the effect will be at the end. So that's the kind of uncertainty that it has to consider.

(08:47):

And finally, with all the financial market stress in recent days or weeks I should say, it makes the task for the Fed even more difficult because it has to balance fighting inflation, keeping the economy on a kind of stable and no recession path, and also trying to prevent a stronger stress scenario on financial markets.

Marcus Winter (09:08):

Oliver, one of the other topics that has been discussed quite frequently over the last months is the currency fluctuation that we had in 2022. What do you see as the big impact and do you have a perspective on that?

Oliver Buesse (09:22):

Yeah, I mean we saw very strong US dollar against all major currencies last year. It somewhat reversed in the final quarter, but overall the US currency increased in value. For example, the Euro until the end of the third quarter lost roughly 14% of its value against the US dollar and was in part, this was driven by the strong Fed reaction as compared to the European central bank. Strong currency movements always have an impact on the reinsurance market because many leading global reinsurers are located in Europe and they have balance sheets in Euro or in Pound sterling or Swiss francs. And if those currencies lose value against the US dollar, there is an immediate decline in effective capacity provided to the US market. And I think that's what happened last year. If you think about 2023, it's very difficult to make any predictions about currency movements. Currency markets are very efficient, so it's quite close to impossible to predict them. What we should think about at least is as we live in very volatile times, again, larger currency shifts are not a tail risk. So that's something we should keep in mind

Marcus Winter (10:38):

Talking about major risks, Oliver, what else are you tracking?

Oliver Buesse (10:42):

First of all, we are tracking a couple of geopolitical risk scenarios. As I mentioned already, it's one of the key topics to monitor. I could start in Europe. We still have the war here, and there's a risk broadening of the conflict. I won't speculate about military scenarios, but it's an obvious risk which implications for the world economy as well. The second risk is China and its relation towards the Western countries and the US in particular, which is turning increasingly difficult. Taiwan is a specific issue here, so that's something that needs close monitoring. And the third one is the Middle East region. It's not as important as it was in the 1970s when we had the last period of very high inflation driven by an energy market shock, the oil crisis, but it's still the region that needs monitoring. And if you think about conflict constellations here, Iran is a specific actor here, especially since it's planning to develop nuclear arms, which could increase the room for conflict.

(11:47):

If you think about these scenarios, all of these scenarios would create shock events, which would have negative implications on economies on financial markets. And depending on the circumstances, this could lead to various sharp recession even. What we should not focus only on geopolitics. There are two other points to watch. Obviously is financial markets, as we've seen in recent weeks with increased interest rates, high leverage, over-indebtedness, at least in certain sectors and high volatility. This is kind of creating a difficult environment and we could see more risk and more stress popping up in the system, which would have economic consequences.

(12:32):

And finally, as we've seen in 2020, a pandemic is a realistic risk scenario, so we should not treat another pandemic as a wild card scenario only, but try to be prepared.

Marcus Winter (12:47):

Oliver, as you know, I ask all my guests the same question. If you had a magic wand, what would you do to bring us back on a path to global prosperity?

Oliver Buesse (12:56):

Well, that's kind of a challenging question. I think there's an easy answer to this from my perspective, being an economist. If we would reduce the scale and the sources of global conflicts, it would be much easier to improve global prosperity because those conflicts not only bring about severe harm to people affected, but if you think about it economically, they're also very costly. So if you could avoid spending so much money on military spending and on conflict, we'd be able to use it in more peaceful ways, and this would very likely improve the world economy and prosperity.

(13:36):

Let me point out some arguments for being optimistic, despite all these downside scenarios. If you think about historical developments, so more longer term, global prosperity has actually increased, and in many parts of the world, extreme poverty has been reduced. So we can be optimistic that the drivers of this development and technology is a very important one, will be there with us also in the future. So in my view, further technological developments, think about biotechnology, for example, will be able to raise prosperity further on a global scale.

Marcus Winter (14:15):

Oliver, I have really enjoyed our conversation on economic indicators and how they impact our industry. Your wealth of knowledge in this space is so valuable, not only to me but to our clients as well. Thank you for taking the time to share your expertise with us.

Oliver Buesse (14:30):

Thank you, Marcus.

Marcus Winter (14:31):

Stay tuned for our next episode. We will examine the status of the property market in US coastal states. Bye for now and see you next time or Nothing Assumed.