Soft Landings but Economic and Policy Divergence
Modest economic growth sets the backdrop for European insurers early in 2025. The global economy still seems broadly on track for a soft landing, and long-term inflation remains subdued. Because energy prices are stable, we’re more confident that inflation will gradually slow over the short to medium term. But a confluence of forces suggests that inflation rates will be above central bank targets, with banks continuing to ease policy at their own paces.
The US economy looks set for an even softer landing; euro-area growth risks tilted to the downside—though recession risks are likely contained. We expect the periphery to outpace core economies. Inflation should decline to target in 2025, enabling the European Central Bank to cut rates to neutral. The UK budget is expansionary and inflationary, so we expect stronger economic growth and a slower decline in inflation, with the Bank of England cutting rates more gradually.
The Investment Landscape for Insurers
Rates are down from their highs of the last couple of years, reducing solvency buffers—though buffers are still above pre-pandemic levels. Coupled with tight spreads, we think these changes to the macro landscape could spur an intensified focus on asset-liability management, hedging programs and the solvency efficiency of investments.
We think interest rates are likely to fall a little further in the medium term along with more divergence among central banks. The world’s three biggest economic drivers—the US, Europe and China—have become more diverse, so we expect rate paths and risk-asset valuations to follow. This could affect hedging costs, but we think the benefits of geographic diversification and relative outlooks for the US and Europe make this a cost worth bearing.
Barbell Exposure a Consideration in Credit
In credit markets, spreads remain at all-time lows, with little to suggest further tightening. But spreads have historically shown the ability to stay tight for a while. The shorter the duration, the tighter the credit spread versus historical averages—so, while spreads are tight, we think this hints at better value for credit risk in short-duration segments.
Ultimately, though, it’s critical for insurers to get aggregate duration positioning right—including key rate durations. We think it makes sense to barbell spread-risk exposure—spending more of spread-risk budgets in short-duration while leaning away from investment-grade corporates in long-duration exposures—balancing these long-duration buckets with government debt and private exposures. Such an approach could enable insurers to exploit better relative value and diversify balance sheet exposures.
From a big-picture perspective, the opportunity set across fixed income is wide-ranging. So, it seems sensible to us to consider a dynamic approach across sectors, including investment-grade debt, higher yielding credit and securitized assets. This provides the flexibility needed to lean into areas of opportunity as they emerge.