Paul Carroll
We've had a prolonged dance with the Federal Reserve over whether they would cut rates again this year, and they finally did, on Dec. 10, right as you and I began this conversation. They also signaled they’re probably done for a while. Where do we go from here?
Michel Léonard
First, I think the Fed made a policy mistake by cutting rates and changing monetary outlook from easing to holding. Setting expectations is more impactful on growth than actual rate changes. By saying “don’t expect rate cuts” they took the wind out of the current easing’s impact. We’re lucky the stock market didn’t drop by 4-5% in the days since.
Instead, the proper policy would have been, in my and many economists’ opinion, to skip the cut but keep easing expectations alive. That would have a strong multiplying impact on GDP.
Had the Fed stuck to easing, we would have started to see decreases in mortgage and auto loan rates by Q3 2026. We needed those lower rates to fuel homeowners and personal auto insurance premium volume growth. Instead, we’re likely to face historically high mortgage and auto loan rates through Q1 2027. Most likely, we’re stuck with weak housing starts, weak existing home sales, and lower auto sales, and without that homeowners and personal auto premium volume driver.
Commercial property, especially, needed the Fed’s help. We have all these commercial Class A downtown conversions into housing sitting still. This is Q4 2023 all over again: The Fed said, Don’t expect more rate cuts – and took the wind out of economic activity throughout 2024. It was just starting to recover by now. The Fed took the wind out of Class A conversions then, and it’s going to do it again. Conversions were starting to recover – now expect no significant changes until Q4 2026.
It’s likely the Fed just caused another soft year of overall U.S. GDP growth and P&C insurance underlying growth, especially when it comes to economic premium volume growth drivers.
I was just looking at premium volume growth for homeowners, personal auto, and commercial property in 2025. Typically, actuaries build in a baseline for premium volume growth by adding net GDP growth and CPI. For 2025, that would bring us to about 7%. But premium volume growth for those lines is below 5%. The argument can be made that, at that level, premium volume growth was flat to negative in 2025.
Paul Carroll
You make a compelling case, as always. So why do you think the Fed cut rates again?
Michel Léonard
I was surprised that the Fed would cut once this year. I was surprised when they cut twice, and I was speechless when they cut a third time.
The Fed's estimate is for real GDP growth to decrease to about 1.7% by 2027. That's starting to be at the lower end of their goal. They do not see inflation picking up significantly, which is probably why they felt comfortable with the statement about further cuts.
But they’re totally flying blind here.
There’s the diminishing growth multiplier impact of rate cuts by changing expectations from easing to holding. Perhaps even more so, the Fed decided to do this with no GDP numbers since June, and no CPI and employment numbers since September. For GDP, getting data for Q3 was critical because of inventory depletion in Q2. The same for getting CPI and unemployment numbers through November. You can’t make decisions about monetary policy without those three. How about without even one?
Paul Carroll
With Trump expected to name his next nominee to run the Fed in January, does that introduce another layer of uncertainty into the equation?
Michel Léonard
There’s a lot of noise in the market asking why the Fed made the statement about the direction of monetary policy. It did not need to. One view is that it did so to preempt rate cuts-galore next year with Trump’s new appointment(s). I don’t think that’s the case.
First, there are many governors other than the chairman who get to vote on rates.
Second, the Fed has already altered its inflation target. A rate cut with CPI at 3.0% means the current board of governors already tolerates annual inflation up to 3.5% (significantly more than the former 2.0% goal).
Third, I was surprised by how mainstream the president’s leading candidate for Fed governor, Stephen Miran, is. He’s a consensus candidate, even though he might put more emphasis on growth than price stability when it comes to the Fed’s dual mandate. Personally, I see that shift, within reason, as beneficial to the overall economy. That said, tolerating inflation up to 3.5% is not the same as up to 4.0%. That would ring alarm bells even from me.
Now keep in mind that an increase of one percentage point in tolerable annual inflation is a significant number. For context, 1% compounded over a 35-year career means U.S. households have to increase their annual savings by 21% just to keep up.
Paul Carroll
What dates should we keep in mind for releases of economic data, so we know whether we’re getting a nice present or a lump of coal in our stocking?
Michel Léonard
The next key date is Dec. 16, for unemployment data. A couple of days later, we get CPI, then GDP on the 23rd. Let me walk through these in chronological order, starting with unemployment.
The recent ADP numbers were a bit worse than expected but certainly within an acceptable range. We're currently at 4.40% unemployment in the U.S., and the consensus is that the new number will be 4.45%. If we get anywhere above 4.45% or 4.5%, I think the market may start reacting. [Editor’s note: The unemployment rate came in at 4.6%.]
The market consensus for the CPI number right now is 3.05%. I think we can be fine up to 3.2% or 3.25%. If we get above that, if we get to 3.5%, that might not be catastrophic, but it would certainly be the last nail in the coffin of further rate cuts. [Editor's note: The CPI number came in at 2.7%. There were, however, anomalies in data collection because of the government shutdown, so the number is being treated with some caution.]
Now we get to GDP. The market consensus expectation for Q3, at 2.48% growth annualized, is much more than I and the Fed think is feasible, which is around 1.9% and 2.0%. The market consensus is likely overly optimistic because Q2 GDP reached 3.8% on a quarterly basis. Again, we’re flying blind.
Paul Carroll
We’ll have another of these conversations in January, and there’s so much uncertainty now, even about the economic numbers, that I can imagine you’ll want to hold your thoughts about next year until then, but can I tempt you into making any projections about 2026?
Michel Léonard
Market reaction to the Q3 and November economic releases will be critical in determining the course of the economy in the next six months, which makes that Dec. 23 release unusually significant in terms of potential impact on the equity market, consumer spending, and private commercial capital investments.
My concern with the equity markets is the Fed's statement about expectations. And you can write this down: I think that decision is the most ill-advised the Fed has made in three years.
Paul Carroll
Thanks, Michel. Great talking to you, as always.
