U.S. financial institutions have looked forward to the return of a higher interest rate environment for some time, but the swift pace of rate increase by the Federal Reserve has sparked recessionary fears and turmoil in the markets.
Recovery in the aftermath of the COVID-19 pandemic has brought elevated inflation not seen in 40 years, prompting the Fed to tighten monetary policy at the quickest pace in three decades. The aggressive actions by the central bank have pushed interest rates considerably higher, boosting earning-asset yields and margins for many financial institutions. However, inflation and the Fed's response have also sparked recessionary fears, clouded the economic outlook and forced investors and startups to allocate capital with greater discipline to put profitability at the forefront and shift away from growth at all costs.
Many financial institutions welcome the return of higher interest rates, but it brings its share of risks as well. Higher rates and elevated inflation have raised recessionary fears and the prospect of notably higher loan losses for banks, slower growth for life insurers, risks to downside for the property and casualty insurance space and much greater demands from investors supporting financial technology startups.
Higher rates are generally positive for U.S. banks, which will see their net interest margins recover, but they also threaten credit quality since the shift and elevated inflation promises higher costs for borrowers.
Inflation threatens to end the U.S. P&C industry's longest streak of calendar-year underwriting profitability in decades in 2022, but we expect it to fuel outsized premium growth through 2023. The U.S. life and annuity industry has long waited for rising rates, but the financial markets volatility that has accompanied them will make for an uneven impact on individual carriers. Products that provide principal protection such as fixed deferred annuities and fixed indexed annuities offer both a safe haven and, through the early stages of the hardening cycle, crediting rates that may be more attractive than bank certificates of deposit. A bear market, meanwhile, could continue to stymie sales of variable annuities.
The changing environment has possibly had the largest impact on fintechs. Higher rates and recessionary fears have prompted investors to demand discipline from growth-oriented companies, shifting management focus to achieving near-term profitability. Startups across the sector are now intent on cutting costs, which has often meant mass layoffs. But other expenses are also being reined in, including ad spend.
Fed efforts to tame inflation point to liquidity pressures at US banks
Higher interest rates will push bank margins notably higher in 2022. Deposit costs have only climbed modestly through the first half of 2022 but will rise more quickly in the second half of the year and increase even further in 2023, slowing margin expansion.
Inflationary pressures on some US P&C business lines offset benefits of higher rates
Inflationary pressures on some U.S. P&C business lines in 2022 will set the stage for continued outsized written premium growth in 2023, even in the context of an economic downturn, S&P Global Market Intelligence projects. In the meantime, we expect those pressures will lead to the industry posting a calendar-year combined ratio for 2022 in excess of 100% for the first time since 2017.
Recessionary fears, normalized credit trends for banks on the horizon
Higher rates and elevated inflation have also raised recessionary fears and the prospect of notably higher loan losses. We expect credit costs to normalize in 2023 and prevent earnings from growing from year-ago levels but believe that losses will be manageable.
Recession brings risks for life insurers
Macroeconomic conditions could shift to a headwind from a tailwind for the life insurance industry. Rising interest rates have fueled especially strong expansion in individual fixed deferred and indexed annuities in 2022. But we expect overall life, annuity and accident-and-health premiums and considerations to grow at a considerably slower pace in 2023, with a projected rate that is less than half of our 2022 estimate of 6.4%.
Rewriting the fintech playbook
Fintech stocks have taken a beating, causing startups to focus on profitability instead of supercharged revenue growth. Numerous startups across the fintech industry conducted layoffs in the summer of 2022 after some boosted head count significantly in 2021. We expect this trend to continue as companies rightsize their operations to meet the tempered growth expectations of investors.
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