Why the hurricane season matters for the Federal Reserve

view original post

Unlock the Editor’s Digest for free

The writer is a former chief investment strategist at Bridgewater Associates

While the US Federal Reserve may not want to complicate its policy mandate by incorporating climate considerations, it increasingly needs an understanding of meteorology to see where the economy is headed.

Hurricane season started on June 1, providing a timely illustration of the weather-driven challenges faced by the Fed, which holds a monetary policy meeting next week. The US National Oceanic and Atmospheric Administration is predicting an above-normal rate of 8-13 hurricane-strength storms before the end of November.

Historically, most investors and Fed officials would shrug off this sort of weather event. After all, hurricanes have typically represented one-off shocks that might impede US energy supply in the Gulf of Mexico and regional spending, but only for very short periods. These storms could create tactical trading opportunities for short-term investors, but they weren’t large or sufficiently durable catalysts that they would influence broader economic trends — or require a monetary policy response.

That calculus might be changing, however, as storms grow in frequency and cost and have broader macro implications. As someone who grew up in Florida and still has ties to the state, I’ve seen this meteorological evolution first-hand. The data backs up my observations.

A recent report from Noaa, for example, found that hurricanes, alongside other US weather events with costs of $1bn or more, averaged 3.3 events per year on average during the 1980s. In subsequent decades, that number rose steadily; over the past three years, an average of 22 events per year were recorded. The cost of these events has risen sharply, from an average $21.7bn a year in the 1980s to $146bn a year over the past three years, adjusting for inflation.

Such weather damage is increasingly extending beyond shortlived interruptions to energy supply or postponed consumption, changing both how investors trade weather events but also how policymakers consider them as they think about risks to their economic forecasts. Indeed, one of the biggest financial effects for consumers is something not fully captured in Fed data: homeowner’s insurance.

US home insurance, especially in parts of the US more prone to weather events, is rising significantly. A March report by the Federal Home Loan Mortgage Corporation, or Freddie Mac, estimated that the annual homeowner’s insurance premium increased between 2018 to 2023 by more than 40 per cent. While a significant part of this reflects higher home and land valuations, Freddie Mac attributes some of the higher cost to greater risks of weather events such as hurricanes.

This particular source of inflation is under-represented in important reports that feed into Fed policy decisions. The consumer price index, or CPI, for instance, only incorporates insurance paid for rental units, not homes. Meanwhile, the Fed’s preferred inflation measure, the personal consumption expenditures index, does include homeowner insurance. However, an estimated sum paid by insurance groups on claims is subtracted from what homeowners pay.

While insurance is a small piece of the broader inflation picture, the change in the rate of price increases is still noteworthy, and brings with it at least three risks for policymakers to consider.

First, the methodology used to calculate CPI and PCE may underestimate the actual inflation being experienced by homeowning households. A second, related risk, is that consumers who need to use more of their income for items such as insurance will have less afterwards to spend on other goods and services. Reduced demand could in turn lead businesses to become more cautious. Such a negative feedback loop could ultimately influence the other half of the Fed’s mandate, the labour market.

Finally, the higher cost of homeowner (and other) insurance is feeding into what is increasingly discussed as a K-shaped economy, with lower-income and wealth groups less able to absorb higher living costs relative to their wages. Freddie Mac’s study, for instance, found that between 2018 and 2023, very low-income borrowers’ homeowner insurance premiums represented 3.1 per cent of their monthly income, double that of middle-income borrowers and about triple that of high-income groups.

For Fed officials, the widening gap between the top and bottom of the US economic “K” means that however they set monetary policy, it will not be optimal for one part of the population. Maybe we’ll avoid a perfect storm this season, but clear economic policy skies don’t seem likely anytime soon.