Part 1: Recent Economic and Financial Developments

Monetary Policy Report submitted to the Congress on June 17, 2022, pursuant to section 2B of the Federal Reserve Act

Domestic Developments

Inflation continued to run high...

After surging 5.8 percent over 2021—the largest increase since 1981—the price index for personal consumption expenditures (PCE) continued to post notable increases so far this year, and the change over the 12 months ending in April stood at 6.3 percent (figure 1). This pace is well above the FOMC's longer-run objective of 2 percent.

...reflecting further large increases in food and energy prices...

Grocery prices increased at a very rapid pace of 10 percent over the 12 months ending in April, more than 4 percentage points faster than over the 12 months ending in December and the highest reading since 1981 (figure 2). Food commodity prices (such as wheat and corn), which had already increased last year, have risen further since Russia's invasion of Ukraine. At the same time, high fuel costs, supply chain bottlenecks, and high wage growth have also pushed up processing, packaging, and transportation costs for food.

The PCE price index for energy increased 30 percent over the 12 months ending in April, about the same pace as over the 12 months ending in December. Large increases in crude oil and natural gas commodity prices have boosted consumer prices for gasoline and natural gas.

...which, in turn, partly reflected rising prices of commodities and imports

Because of Russia's invasion of Ukraine, oil prices rose sharply in early March, reaching eight-year highs (figure 3). Prices remain elevated and volatile, boosted by a European Union embargo of Russian oil imports but weighed down at times by concerns about global economic growth. In addition, producers in other countries are struggling to ramp up oil production.

Nonfuel commodity prices also surged after the invasion, with large increases in the prices of both agricultural commodities and industrial metals (figure 4). Although the price of industrial metals has declined recently, agricultural prices remain elevated. Ukraine and Russia are notable exporters of wheat, Russia is a major exporter of fertilizer, and higher energy prices are spilling over into the agricultural sector. Export restrictions and unfavorable weather conditions in several countries have also boosted agricultural prices. (See the box "Developments in Global Supply Chains.")

With commodity prices surging and foreign goods prices on the rise, import prices increased significantly (figure 5).

Developments in Global Supply Chains

Bottlenecks in global production and transportation remain a major impediment for both domestic and foreign firms. Russia's invasion of Ukraine and the widespread COVID-19 lockdowns in China have exacerbated strains in global supply networks and have led to greater uncertainty about the timing of improvement in supply conditions.

Despite this turbulence in the global supply network, U.S. manufacturers have been recording solid output growth for more than a year. There have been gains in domestic motor vehicle production, as the supply of semiconductors has recovered somewhat (figure A). In addition, survey results suggest shorter supplier delivery times and lower order backlogs relative to their late 2021 levels (figure B). Notwithstanding these improvements, backlogs and delivery times for the sector remain elevated, and light vehicle assemblies are still a bit below pre-pandemic levels, with low dealer inventories continuing to constrain sales. For some materials that had previously been in short supply—such as lumber and steel—prices have declined from notable highs. Even so, the overall producer price index for manufacturing in April was more than 18 percent above its year-earlier level (figure C). Progress has been similarly mixed for bottlenecks in the transportation of goods. The number of ships waiting for berths at West Coast ports has declined noticeably, as port throughput has remained high, although manufacturers continue to cite logistics and transportation constraints as reasons for lower output.

Risks to supply chain conditions abound, including those arising from COVID-19 lockdowns in China beginning in mid-March and the ongoing war in Ukraine.1 Committed to their zero-COVID strategy, Chinese authorities ratcheted up restrictions quickly in the face of rising cases of the Omicron variant, which included a complete lockdown of Shanghai. The containment strategy managed to reduce case counts, allowing authorities to begin relaxing some citywide restrictions in late April. The lockdowns drove the largest monthly declines in Chinese activity since early 2020, with industrial production dropping about 13 percent between February and April (figure D) before recovering some in May. With severely disrupted domestic logistics, supplier delivery times increased sharply in April and continued increasing in May, but not as strongly (figure E). Chinese international trade was also hit, contracting in the three months before April (figure F). As Chinese production continues to recover, the associated rebound in trade flows may further strain international transportation networks.

The invasion of Ukraine by Russia is causing economic hardship. For instance, the conflict has disrupted global commodity markets in which Ukraine and Russia account for significant shares of global exports. Notably, energy prices have soared, as increasing geopolitical tensions have put the supply of Russian oil and gas to Europe at risk. Indeed, Russian energy exports have already been falling amid embargos on Russian oil, self-sanctioning by some companies, transportation difficulties, and Russia's decision to halt gas deliveries to several European countries. The prices of several nonfuel commodities that are vital inputs to some manufacturing industries jumped in the early days of the conflict, including neon gas (an input in semiconductor chip production), palladium (an input in semiconductors and catalytic converters), nickel (an input in electric vehicles' batteries), and platinum. However, prices have since retreated to near pre-invasion levels as major disruptions have failed to materialize thus far. Finally, blocked shipping routes in the Black Sea have severed the region's agricultural exports, disrupting global food markets. As a result, prices of corn, wheat, sunflower oil, and fertilizer have climbed to record-high levels, raising concerns of food insecurity across the globe. Further aggravating the situation, a number of countries introduced export bans on some food commodities to contain rising domestic food prices.

Thus far, the war appears to have had more limited effects on other aspects of global supply chains. The effect on supplier delivery times across Europe has been muted, suggesting that the repercussions for manufacturers in the region have been relatively modest so far outside of the shifts in commodity prices (figure G). The global transportation system has also proved mostly resilient to the war, with signs of further strain in only a couple of sectors. Oil tanker charter rates spiked, boosted by a rise in demand as oil started to move to new markets, while truck transportation prices rose further, reflecting higher diesel fuel costs.

1. The July 1 expiration of the contract between dockworkers and West Coast port operators poses an additional risk for shipping-related disruption. Return to text

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Excluding food and energy prices, monthly inflation readings have softened since the turn of the year but remain far above levels consistent with price stability

Supply chain issues, hiring difficulties, and other capacity constraints have prevented the supply of products from rising quickly enough to satisfy continued strong demand, resulting in large price increases for many goods and services over the past year. After excluding consumer food and energy prices, the 12-month measure of core PCE inflation rose initially and then fell back to 4.9 percent in April, unchanged from December.

That said, monthly core inflation readings have softened noticeably since the start of the year, with the three-month measure of core PCE inflation falling from an annual rate of 6.0 percent last December to 4.0 percent in April. In particular, inflation stepped down for durable goods, likely reflecting some easing in supply constraints.

Nevertheless, the recent inflation readings have been mixed, remain far above levels consistent with price stability, and are far from conclusive evidence on the direction of inflation. Unlike durable goods price inflation, core services inflation has not declined significantly. Housing service prices continue to rise at a brisk pace, and increased demand for travel is markedly pushing up inflation rates for lodging and airfares. More generally, rapid growth of labor costs is putting upward pressure on the prices of all labor-intensive services.

Measures of near-term inflation expectations continued to rise markedly, while longer-term expectations moved up by less

The first half of 2022 saw further increases in expectations of inflation for the year ahead in surveys of both consumers and professional forecasters (figure 6). In the University of Michigan Surveys of Consumers, the median value for inflation expectations over the next year jumped to 5.4 percent in March, its highest level since November 1981, and has moved sideways since then. A portion of the upward movement so far this year likely reflects the war in Ukraine and the accompanying increases in the prices of commodities, especially those related to energy and food.

Longer-term expectations, which are more likely to influence actual inflation over time, moved up by less and remained above pre-pandemic levels. The Michigan survey's median inflation expectation for the next 5 to 10 years rose to 3.3 percent in the June preliminary reading. If confirmed, this reading would be near the top of the range from the past 25 years. Nevertheless, it remains well below the corresponding measure of 1-year-ahead inflation expectations. In the second-quarter Survey of Professional Forecasters, the median expectation for 10-year PCE inflation edged up to 2.4 percent, reflecting noticeable upward revisions to expected inflation this year and next but little change thereafter; the median expectation for 6 to 10 years ahead held steady at 2 percent.

Market-based measures of longer-term inflation compensation, which are based on financial instruments linked to inflation, are sending a similar message. A measure of consumer price index (CPI) inflation compensation 5 to 10 years ahead implied by Treasury Inflation-Protected Securities is little changed (on balance) since late 2021 and remains well below the corresponding measure of inflation compensation over the next 5 years (figure 7).

The Index of Common Inflation Expectations, which is produced by Federal Reserve Board staff and synthesizes information from a large range of near-term as well as longer-term expectation measures, edged up in the first half of this year and now stands at the high end of the range from the past 20 years.

The labor market continued to tighten

Payroll employment expanded an average of 488,000 per month in the first five months of the year (figure 8). Payroll gains so far this year have been broad based across industries, with the leisure and hospitality sector continuing to see the largest gains as people continued their return to activities that had been cut back by the pandemic.

The increase in payrolls was accompanied by further declines in the unemployment rate, which fell 0.3 percentage point over the first five months of the year to 3.6 percent in May, just above the bottom of its range over the past 50 years (figure 9). The decline in the unemployment rate has been fairly broad based across age, educational attainment, gender, and ethnic and racial groups (figure 10). These declines have helped employment of nearly all major demographic groups recover to near or above their levels before the pandemic. (See the box "Developments in Employment and Earnings across Groups.")

Developments in Employment and Earnings across Groups

Labor market gains have been robust over the past year and a half as the economy continues to recover from the effects of the pandemic. Historically, economic downturns have tended to exacerbate long-standing differences in employment and earnings across demographic groups, especially for minorities and for those with less education, and this pattern was especially true early on in the pandemic. However, as pandemic-related factors have eased and the labor market has recovered, groups with larger employment declines early in the pandemic have had especially large increases lately. Now employment and real earnings of nearly all major demographic groups are near or above their levels before the pandemic, and employment rates are again near multidecade highs.

Different age groups have had very different employment experiences over the course of the pandemic.1 Early in the pandemic, the employment-to-population (EPOP) ratio for people aged 16 to 24 not only declined by much more than that for people of prime age (25 to 54) and those aged 55 to 64, but also recovered much more quickly (see figure A, upper-left panel).2 Conversely, employment recovered more slowly for prime-age people throughout 2020 and nearly all of 2021. But in late 2021 and early 2022, the prime-age EPOP rose quickly, such that now all three of these age groups' EPOP ratios have essentially recovered to their pre-pandemic levels. The EPOP ratio for those aged 65 and over, however, remains about 1 percentage point below its pre-pandemic level—a level it has maintained through much of the pandemic. The lower EPOP ratio for that group is entirely attributable to a lower labor force participation rate, which in turn largely reflects an increase in retirements since the onset of the pandemic.

A closer look at the prime-age group shows that there has been considerable heterogeneity in the pace of the employment recovery across race and ethnicity, educational attainment, and parental status. Employment for Blacks and Hispanics not only declined by more than that for whites and Asians early in the pandemic, but also recovered more quickly since the end of last year (figure A, upper-right panel). In addition, men and women with high school degrees or less saw larger declines and a faster recovery (figure A, lower-left panel). Similarly, gaps in employment between prime-age mothers and non-mothers that widened through 2020 have essentially closed (figure A, lower-right panel). By April 2022, employment for all of those groups was near or above its pre-pandemic level.

These differences in the timing of the employment recovery across different demographic groups partly reflect the evolution of the pandemic's effect on the labor market. For instance, social-distancing restrictions and concerns about contracting or spreading COVID-19 had likely inhibited employment in in-person services. As these restrictions and concerns have waned, employment of groups more commonly employed in in-person services, such as those with less education and some minority groups, has recovered quickly.3 Further, the closing of many schools and childcare facilities for the 2020–21 school year due to elevated levels of COVID cases likely held back the employment recovery of parents, as many families faced uncertainties about the consistent availability of in-person education for school-age children and childcare for younger children. The effects appear to have been particularly acute for mothers, especially Black and Hispanic mothers, as well as those with less education.4 However, with schools having generally provided in-person education for the 2021–22 school year, these childcare burdens likely eased, allowing many parents to reenter the workforce.

Although the gaps in employment outcomes across groups that widened during the pandemic have diminished, the considerable gaps that existed before the pandemic remain. For example, the EPOP ratio for whites of prime age remains more than 3 percentage points above those for prime-age Black and Hispanic people; the EPOP ratio of college-educated, prime-age people is about 15 percentage points higher than that of prime-age people with high school degrees or less; and the EPOP ratio for prime-age mothers is about 5 percentage points below that of non-mothers—all similar in size to the gaps that existed before the pandemic.

The broad-based nature of the labor market recovery is also apparent in workers' earnings, which have grown rapidly as employment surged in 2021 and early 2022. As of 2022:Q1, the median full-time worker's usual weekly earnings had grown 12.3 percent relative to pre-pandemic levels—implying real earnings growth of 3.1 percent (figure B).5 Although this earnings growth has been widespread, it has been largest for women, minorities, young workers, and workers with less than a high school education. The growth in earnings for some demographic groups has been sufficiently robust to shrink some pre-pandemic disparities in real earnings between groups. For instance, the gap in median full-time real earnings for women versus men is slightly smaller in 2022:Q1 than it was in 2019, as is the gap in median real earnings between Black and white full-time workers.6

1. The January 2022 employment report incorporates population controls that showed that the working-age population was both larger and younger over the past decade than the Census Bureau had previously estimated. Those population controls had meaningful effects on the aggregate EPOP ratio but much smaller effects at the levels of disaggregation examined in this discussion. Return to text

2. This discussion defines the pre-pandemic baseline EPOP ratio for each group as that group's average EPOP ratio over 2019. Return to text

3. Before the pandemic, Blacks and Hispanics were less likely to be employed in jobs that could be performed remotely, and women and Blacks were more likely to be employed in occupations that involved greater face-to-face interactions; for example, see Laura Montenovo, Xuan Jiang, Felipe Lozano Rojas, Ian M. Schmutte, Kosali I. Simon, Bruce A. Weinberg, and Coady Wing (2020), "Determinants of Disparities in COVID-19 Job Losses," NBER Working Paper Series 27132 (Cambridge, Mass.: National Bureau of Economic Research, May; revised June 2021), Other research shows that even after accounting for workers' job characteristics, Hispanic and nonwhite workers experienced a higher rate of job loss relative to other workers; see Guido Matias Cortes and Eliza Forsythe (2021), "The Heterogeneous Labor Market Impacts of the Covid-19 Pandemic," unpublished paper, August, Return to text

4. The increase in the share of mothers of school-age children who reported being out of the labor force due to caregiving closely tracked the degree to which schools were fully closed to in-person learning over the 2020–21 school year, and districts that serve more Blacks and Hispanics were less likely to provide fully in-person education during the 2020–21 school year, which may account for some of the larger and more persistent declines in labor force attachment for Black and Hispanic mothers over this period. See Joshua Montes, Christopher Smith, and Isabel Leigh (2021), "Caregiving for Children and Parental Labor Force Participation during the Pandemic," FEDS Notes (Washington: Board of Governors of the Federal Reserve System, November 5), Return to text

5. Just as with the change in the EPOP ratio, each group's pre-pandemic baseline is defined as the group's average median usual weekly earnings in 2019. The reported growth in real usual weekly earnings deflates nominal earnings growth by total PCE (personal consumption expenditures) inflation. If, instead, the CPI were used to deflate nominal earnings, then reported real earnings growth since 2019 would be 2 percentage points lower—but even when using the CPI to deflate nominal earnings, real earnings have risen for most groups since 2019. Return to text

6. Some of a group's earnings growth relative to 2019 may reflect lingering pandemic-related compositional shifts in the group's full-time workers. Additionally, real earnings growth accounts for aggregate inflation, but some demographic groups may be disproportionately exposed to inflation due to differences in groups' consumption patterns—implying lower real earnings growth for groups with greater exposure to inflation. Return to text

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While labor demand remained very strong, labor supply increased only modestly and stayed below pre-pandemic levels

Demand for labor continued to be very strong in the first half of the year. At the end of April, there were 11.4 million job openings—60 percent above pre-pandemic levels and down a bit from the all-time high recorded in March.

Meanwhile, the supply of labor rose only gradually and remained below pre-pandemic levels. The labor force participation rate (LFPR), which measures the share of people either working or actively seeking work, edged up just 0.1 percentage point in the first five months of the year—following a 0.4 percentage point improvement last year—to 62.3 percent in May (figure 11).2

Despite these improvements, the LFPR remains 1.1 percentage points below its February 2020 level.3 About one-half of this decline in the participation rate was to be expected even in the absence of the pandemic, as additional members of the large baby-boom generation have reached retirement age. In addition, several pandemic-related factors appear to be continuing to hold down the participation rate, including a pandemic-induced surge in retirements (beyond that implied by the aging of the baby boomers) and, to a diminishing extent, increased caregiving responsibilities and some continuing concerns about contracting COVID-19.

In addition to subdued participation, a second factor constraining the size of the labor force has been a marked slowing in population growth since the start of the pandemic. Over 2020 and 2021, the working-age (16 and over) population grew by 0.4 percent per year on average—notably less than the 0.9 percent average rate over the previous five years.4 The slowing in population growth over 2020–21 was due to both a sharp decline in net immigration and a spike in COVID-related deaths.5 Had the population increased over 2020–21 at the same rate as over the previous five years, the labor force would have been about 1-3/4 million larger as of the second quarter of this year.6

As a result, labor markets remained extremely tight...

Reflecting very strong demand for workers alongside still-subdued supply, a wide range of indicators have continued to point to an extremely tight labor market despite the fact that the level of payroll employment in May remained about 820,000 below the level in February 2020.7 The number of total available jobs, measured by total employment plus posted job openings, continued to far exceed the number of available workers, measured by the size of the labor force.8 The gap was about 5-1/2 million at the end of April, near the highest level on record.9 The share of workers quitting jobs each month, an indicator of the availability of attractive job prospects, was 2.9 percent at the end of April, near the all-time high reported in November (figure 12). Initial claims for unemployment benefits remain near the lowest levels observed in the past 50 years. Households' and small businesses' perceptions of labor market tightness were near or above the highest levels observed in the history of these series. And, finally, employers continued to report widespread hiring difficulties.

That said, some possible signs of modest easing of labor market tightness have recently appeared. For example, as noted in the next section, some measures of wage growth appear to have moderated. And in the June 2022 Beige Book, employers in some Federal Reserve Districts reported some signs of modest improvement in worker availability.

...and nominal wages continued to increase at a robust pace

Reflecting very tight labor market conditions, nominal wages continued to rise at historically rapid rates. For example, the employment cost index (ECI) of total compensation rose 4.8 percent over the 12 months ending in March, well above 2.8 percent from a year earlier (figure 13). The most recent readings include a surge in bonuses, which may reflect the challenges of retaining and hiring workers. In addition, wage growth as computed by the Federal Reserve Bank of Atlanta, which tracks the median 12-month wage growth of individuals responding to the Current Population Survey, picked up markedly this year and rose more than 6 percent in May, well above the 3 to 4 percent pace reported over the previous few years.

That said, there are some signs that nominal wage growth may be leveling off or moderating. The growth of wages and salaries as measured by the ECI moderated from 5.6 percent at an annual rate in the second half of last year to 5.2 percent early this year. And even as payroll employment continued to grow rapidly and the unemployment rate continued to fall, the three-month change in average hourly earnings declined from about 6 percent at an annual rate late last year to 4.5 percent in May, with the moderation in earnings growth particularly notable for employees in the sectors that experienced especially strong wage growth last year, such as leisure and hospitality.

Following a period of solid growth, labor productivity softened

The extent to which sizable wage gains raise firms' unit costs and act as a source of inflation pressure depends importantly on the pace of productivity growth. Considerable uncertainty remains around the ultimate effects of the pandemic on productivity.

From 2019 through 2021, productivity growth in the business sector picked up (albeit by less than compensation growth), averaging about 2-1/4 percent at an annual rate—about 1 percentage point faster than the average pace of growth over the previous decade (figure 14). Some of this pickup in productivity growth might reflect persistent factors. For example, the pandemic resulted in a high rate of new business formation, the widespread adoption of remote work technology, and a wave of labor-saving investments.

The latest reading, however, showed a decline in business-sector productivity in the first quarter of this year. While quarterly productivity data are notoriously volatile, this decline nevertheless highlights the possibility that some of the earlier productivity gains could prove transitory, perhaps reflecting worker effort initially surging in response to employment shortages and hiring difficulties and then subsequently returning to more normal levels.10 If the gap between wage growth and productivity growth remains comparably wide in the future, the result will be significant upward pressure on firms' labor costs.

Gross domestic product declined in the first quarter of 2022 after having surged in the fourth quarter of 2021...

Real gross domestic product (GDP) is reported to have surged at a 6.9 percent annual rate in the fourth quarter of 2021—and then to have declined at a 1.5 percent annual rate in the first quarter—because of fluctuations in net exports and inventory investment (figure 15). These two categories of expenditures are volatile even in normal times, and they have been even more so in recent quarters. Some improvement in supply chain conditions late last year appears to have enabled firms to rebuild depleted inventories; inventory investment surged in the fourth quarter and then moderated to a still-elevated pace in the first quarter, thereby weighing on GDP growth. Other measures of activity, including employment, industrial production, and gross domestic income, indicate continued growth in the first quarter.

...while growth in consumer spending and business investment was solid in the first quarter

After abstracting from these volatile components, growth in private domestic final demand (consumer spending plus residential and business fixed investment—a measure that tends to be more stable and better reflects the strength of overall economic activity) was solid in the first quarter, supported by some unwinding of supply bottlenecks and a further reopening of the economy. The most recent spending data and other indicators suggest that private fixed investment may be moderating, but consumer spending remains strong and drag from inventory investment and net exports may be dissipating. As a result, private domestic final demand and real GDP appear on track to rise moderately in the second quarter.

Real consumer spending growth remained strong...

Real consumer spending—that is, spending after adjusting for inflation—continued to grow briskly, supported by a partial unwinding of supply bottlenecks and continued normalization of spending patterns as the pandemic fades. For example, spending on motor vehicles grew markedly in the first quarter, reflecting improvements in both domestic and foreign production, and spending on services (especially at restaurants) grew briskly.

That said, consumer spending growth has moderated from its very rapid pace from early 2021 as fiscal support has declined from historical highs, some households have likely depleted excess savings accumulated during the pandemic, and inflation has eroded households' purchasing power.

The composition of spending remains more tilted toward goods and away from services than it was before the pandemic. Real goods spending is still well above its trend, while real spending on services remains below trend (figure 16). Nevertheless, the composition continued to shift back toward services. While goods spending was only modestly higher in April compared with its average from late last year, services spending rose significantly.

...supported by high levels of wealth

Household wealth grew by roughly $30 trillion between late 2019 and late 2021 because of rises in equity and house prices along with the elevated rate of saving in 2020 and 2021 (figures 17 and 18). Since the beginning of the year, wealth has declined because of the drop in equity prices. Nevertheless, wealth remains well above pre-pandemic levels, providing continuing support for consumer spending.

Consumer financing conditions were generally accommodative, especially for borrowers with stronger credit scores

Financing has been generally available to support consumer spending. Following a period of widespread reported easing last year, standards on credit card loans eased somewhat further in the first quarter, whereas those on auto and other consumer loans changed little. Partly reflecting higher credit card purchase volumes, credit card balances grew rapidly in recent months (figure 19). Even so, many credit card users still have ample unused credit. Auto loans grew briskly during the first quarter, consistent with the concurrent rebound in auto sales.

Meanwhile, borrowing costs rose. However, they remain below pre-pandemic levels for credit cards and auto loans, partly reflecting strong consumer credit quality. Indeed, delinquency rates on consumer loans remain low relative to historical averages despite some recent increases among nonprime borrowers.

Housing construction remained high but may be moderating...

New single-family construction has remained well above pre-pandemic levels. However, new construction may be softening, with single-family permits turning down some in March and April (figure 20). As in the past year, still-tight supplies of materials, labor, and other inputs may still be restraining new construction. Also, builders have become distinctly less optimistic about prospects for housing sales, perhaps owing to the sharp rise in mortgage rates (figure 21).

...while home sales fell amid low inventories and rising mortgage rates

Home sales stepped down substantially from the very high levels prevailing late last year and are now close to pre-pandemic levels (figure 22). Some of this decline may have reflected further reductions in inventories of existing homes to historically low levels early in the year. In addition, the sharp increases in mortgage rates may have begun to moderate housing demand. Even so, financing conditions in the residential mortgage market remained accommodative for borrowers who met standard loan criteria, and the terms of mortgage credit for households with lower credit scores continued to ease toward pre-pandemic levels. Listings, sales, and price data suggest that so far, demand remains strong relative to the pace at which homes are being made available for sale. For example, the share of homes off market within two weeks remains elevated, and as of April, several measures of national house prices were up about 20 percent from a year earlier, though less in real terms (figure 23).

Business fixed investment rose strongly in the first quarter but may now be moderating

Investment in equipment and intangibles surged at a 12-1/2 percent annual rate in the first quarter (figure 24). Investment demand remained strong, as worker shortages and high-capacity utilization in manufacturing likely maintained strong incentives for firms to automate production and boost capital expenditures. In turn, strong investment demand continued to boost equipment prices in an environment of constrained supply, but there have been initial signs that supply constraints may have begun to ease. In particular, since late last year, shipments of capital goods have begun to catch up with orders. The most recent indicators suggest that the growth of investment in equipment and intangibles will slow significantly in the second quarter, possibly reflecting drag from tighter financial conditions.

Investment in nonresidential structures declined moderately in the first quarter after falling more rapidly over the second half of 2021, and it appears on track to decline again in the second quarter. Declines in spending on nondrilling structures have been only partly offset by rapid increases in drilling investment, which reflect the recent rise in energy prices.

Business financing conditions tightened somewhat but remained generally accommodative

Credit remained available to most nonfinancial corporations, but financing conditions tightened somewhat, especially for lower-rated firms. Gross nonfinancial corporate bond issuance was solid in the first quarter but slowed somewhat in April and May, with speculative-grade bond issuance particularly weak. Leveraged loan issuance also declined notably in May, partly reflecting weakening demand from retail investors. The growth of business loans at banks picked up from the subdued pace of last year, reflecting stronger loan originations as well as a moderation in loan forgiveness associated with the Paycheck Protection Program.

Credit also remained broadly available to small businesses. The share of small firms reporting that it was more difficult to obtain loans (compared with three months earlier) remained low by historical standards. Loan origination data through April were consistent with credit availability being comparable with pre-pandemic levels amid gradually recovering demand for small business credit. Most measures of loan performance remained largely stable; through April, default and delinquency rates remained below their pre-pandemic levels.

The strong U.S. demand has partly been met through a rapid rise in imports

Driven by the continued strength in domestic economic activity, including still-strong demand for goods consumption, U.S. imports continued to grow at a rapid pace, surging well above their pre-pandemic trend (figure 25). High levels of imported goods have kept international logistics channels operating under high pressure, which has continued to impair the timely delivery of goods to U.S. customers. Real goods exports have only recovered to pre-pandemic levels. Real exports and imports of services remain subdued, reflecting a slow recovery of international travel. Given the recent strength of imports relative to the milder recovery in exports, the nominal trade deficit widened further as a share of GDP (figure 26).

The support to economic activity provided by federal fiscal actions continued to diminish...

In response to the pandemic, the federal government enacted fiscal policies to address the economic consequences of the pandemic. Because the boost to spending from these policies ended last year, the effects on demand are likely waning this year and weighing on GDP growth.

...and, in turn, the budget deficit has fallen sharply from pandemic highs, and the growth of federal debt has moderated

The Congressional Budget Office estimates that fiscal policies enacted since the start of the pandemic will increase federal deficits roughly $5.4 trillion by the end of fiscal year 2030, with the largest deficit effects having occurred in fiscal 2020 and 2021.11 These policies, combined with the effects of the automatic stabilizers—the reduction in tax receipts and increase in transfers that occur as a consequence of depressed economic activity—caused the federal deficit to surge to 15 percent of nominal GDP in fiscal 2020 and remain elevated at 12-1/2 percent in fiscal 2021. But with pandemic fiscal programs having largely ended and receipts surging, the deficit has fallen sharply thus far in fiscal 2022 relative to fiscal 2021 and, by the end of the fiscal year, is expected to be close to the deficits prevailing just before the pandemic (figure 27).

As a result of the fiscal support enacted during the pandemic, federal debt held by the public jumped to around 100 percent of nominal GDP in fiscal 2020—the highest debt-to-GDP ratio since 1947 (figure 28). But with deficits falling and economic growth having rebounded, the debt-to-GDP ratio has since receded slightly from its recent peak.

State and local government budget positions are remarkably strong...

Federal policymakers provided a historic level of fiscal support to state and local governments during the pandemic, with aid totaling about $1 trillion. This aid has more than covered pandemic-related budget shortfalls in the aggregate. Moreover, following the pandemic-induced slump, total state tax collections—pushed up by the economic expansion—rose appreciably in 2021 and continued to grow rapidly in early 2022 (figure 29). In turn, this recovery in revenues has led some state governments to enact or consider enacting tax cuts. At the local level, property taxes have continued to rise apace, and the typically long lags between changes in the market value of real estate and changes in tax collections suggest that property tax revenues will rise quite substantially going forward, given the rise in house prices.

...but hiring and construction outlays have continued to lag

Despite the return to in-person schooling and the strong fiscal position of state and local governments, state and local government payrolls continued to expand only modestly in the first half of 2022. Employment levels have regained about 60 percent of their sizable pandemic losses, falling well short of the recovery in private payrolls (figure 30). One reason for this disparity appears to be that public-sector wages have not kept pace with the rapid gains in the private sector, which may be inhibiting the ability of these governments to staff back up to pre-pandemic levels. Meanwhile, real construction outlays by state and local governments continued to decline in the first half of the year and are currently about 15 percent below pre-pandemic levels.

Financial Developments

The expected level of the federal funds rate over the next few years shifted up substantially

In March, May, and June, the FOMC raised the target range for the federal funds rate a total of 1-1/2 percentage points. The expected path of the federal funds rate over the next few years also shifted up substantially since late February (figure 31). Economic data releases and FOMC communications were viewed by market participants as implying tighter monetary policy than previously expected. Market-based measures suggest that investors anticipate the federal funds rate to exceed 3.6 percent by the end of this year, which is about 2 percentage points higher than the level expected in late February. The same measures suggest that the federal funds rate is expected to peak at about 4 percent in mid-2023 before gradually declining to about 3.1 percent by the end of 2025, which is about 1.4 percentage points higher than the end-2025 rate expected in late February.

Similarly, according to the results of the Survey of Primary Dealers and the Survey of Market Participants, both conducted by the Federal Reserve Bank of New York in April, the median of respondents' projections for the most likely path of the federal funds rate shifted up significantly since January.12

Before late February, the expected path of the federal funds rate had started to increase notably in the third quarter of last year, in anticipation of increases in the target range. Consistent with the rise in the expected path of the federal funds rate, yields on Treasury securities and corporate bonds, as well as mortgage rates, all started to increase materially at a similar time. Meanwhile, broad equity price indexes have declined on net. Overall, these moves in asset prices suggest tightening of financial conditions even before the initial increase in the target range of the federal funds rate occurred in March (figure 32).

Yields on U.S. nominal Treasury securities also rose considerably

Yields on nominal Treasury securities across maturities have risen considerably since late February (figure 33). After a brief dip in late February, following Russia's invasion of Ukraine, yields rose steadily amid higher inflationary pressures and associated expectations for monetary policy tightening. The increases in nominal Treasury yields were primarily accounted for by rising real yields. Uncertainty about longer-term interest rates—as measured by the implied volatility embedded in the prices of near-term options on 10-year interest rate swaps—also increased significantly, reportedly reflecting, in part, an increase in uncertainty about the policy outlook.

Yields on other long-term debt increased substantially

Across credit categories, corporate bond yields have increased substantially and spreads over yields on comparable-maturity Treasury securities have increased notably since late February. Corporate bond yields and spreads are somewhat above the historical median values of their respective historical distributions since the mid-1990s (figure 34). Municipal bond yields also increased significantly while spreads increased somewhat since late February. Spreads on municipal bonds are now moderately above their historical medians. On net, corporate bond spreads are moderately above their pre-pandemic levels, and municipal bond spreads are near levels prevailing shortly before the pandemic. While the widening of corporate bond spreads since late February appears to partly reflect a deterioration in market expectations of future credit quality, corporate and municipal credit quality thus far in 2022 have remained strong. So far this year, defaults have been low, and upgrades of bond ratings have outpaced downgrades in both markets.

Since late February, yields on agency mortgage-backed securities (MBS)—an important pricing factor for home mortgage rates—increased significantly, as longer-term Treasury yields increased and spreads over comparable-maturity Treasury securities widened (figure 35). MBS spreads increased as market participants' expectations of a gradual reduction in the Federal Reserve's balance sheet shifted to a faster reduction.

Broad equity price indexes declined sharply, on net, amid substantial volatility

Broad equity price indexes were volatile and declined sharply, on net, amid sustained inflation pressures and expectations of monetary policy tightening, as well as heightened uncertainty regarding Russia's invasion of Ukraine and the economic outlook (figure 36). Bank stock prices also declined on net. One-month option-implied volatility on the S&P 500 index—the VIX—rose notably to elevated levels in the days following Russia's invasion of Ukraine. The VIX trended down for some time only to increase again and remain elevated since late April amid a notable deterioration in risk sentiment (figure 37). (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability.")

Developments Related to Financial Stability

This discussion reviews vulnerabilities in the U.S. financial system. The framework used by the Federal Reserve Board for assessing the resilience of the U.S. financial system focuses on financial vulnerabilities in four broad areas: asset valuations, business and household debt, leverage in the financial sector, and funding risks. With inflation running higher than expected, the invasion of Ukraine, and the pandemic's continued effects on supply chains and consumer demand patterns, uncertainty about the economic outlook increased, and prices of some financial assets fluctuated widely. Treasury yields increased markedly, and valuation pressures in corporate securities markets eased, but real estate prices have risen further this year despite a rise in mortgage rates. While business and household debt has been growing solidly, the ratio of private nonfinancial credit to gross domestic product (GDP) decreased to near pre-pandemic levels and most indicators of credit quality remained robust. Large bank capital ratios dipped in the first quarter, but overall leverage in the financial sector appears moderate and little changed this year. A few signs of funding pressures emerged amid the escalation of geopolitical tensions. However, broad funding markets proved resilient, and with direct exposures of U.S. financial institutions to Russia and Ukraine being small, financial spillovers have been limited to date. Nevertheless, the effect of high inflation, supply chain disruptions, and the ongoing geopolitical tensions remain substantial sources of uncertainty with the potential to further stress the financial system.

Valuation measures based on current expectations of cash flows decreased in some markets but continued to be high relative to historical norms. Reflecting a less accommodative monetary policy stance associated with elevated inflation and a tight labor market, yields on Treasury securities increased markedly and reached somewhat above their pre-pandemic levels. Broad equity prices fluctuated widely and declined sharply. Prices relative to earnings forecasts declined from previously very elevated levels but were still above their historical median. Corporate-to-Treasury spreads widened but remained below their historical median. Spreads on leveraged loans were little changed, and leveraged loan issuance remained solid. House prices continued to rise at a rapid pace that further outstripped rent growth. Commercial real estate prices also rose further, with some price indexes surpassing their 2006 peaks.

The rapid growth of nominal GDP outpaced the growth of total debt of nonfinancial businesses and households. The ratio of the aggregate debt owed by the private nonfinancial sector to nominal GDP further declined to near pre-pandemic levels (figure A). Net leverage of large nonfinancial businesses held stable at below pre-pandemic levels, supported by ample cash holdings. Fueled by strong earnings and low borrowing costs, the ratio of earnings to interest expenses for the median firm among public nonfinancial businesses rose to its highest level in two decades, indicating that large firms were better able to service debt. However, for firms in industries hit hardest by the pandemic, leverage remains elevated and interest coverage ratios are lower. The financial position of many households continued to improve. Household debt relative to nominal GDP as well as mortgage, auto, and credit card delinquencies were in the bottom range of the levels observed over the past 20 years. Household credit growth has been almost exclusively among prime-rated borrowers, including for residential mortgages. Nonetheless, some households remained financially strained and vulnerable to adverse shocks during this period of heightened uncertainty.

Vulnerabilities from financial-sector leverage are well within their historical range. Risk-based capital ratios at domestic bank holding companies declined some in the first quarter of 2022 but remained well above regulatory requirements. Banks increased loan loss provisions to reflect higher uncertainty about the economic outlook and continued to report that rising interest rates will support their profitability going forward. However, higher interest rates cause losses in the market value of banks' long-term fixed-rate assets. Leverage remained high at life insurance companies and was likely somewhat elevated at hedge funds, though the most comprehensive data for hedge funds are considerably lagged. Vulnerabilities of most U.S. financial institutions to the Russian invasion of Ukraine appear to be limited. Some nonbank financial intermediaries—such as commodity trading firms—have been directly affected by the Russia–Ukraine conflict, but loan exposures of large U.S. banks to these firms and borrowers in Ukraine and Russia are small. However, several indirect channels—heightened volatility in asset markets; new disruptions in payment, clearing, or settlement systems; and interconnections with large European banks—could adversely affect the U.S. economy and financial system.

Funding risks at domestic banks and broker-dealers are low, but structural vulnerabilities persist at some money market funds (MMFs), bond funds, and stablecoins. Banks relied only modestly on short-term wholesale funding, and the share of high-quality liquid assets at banks remained historically high. Assets under management at prime and tax-exempt MMFs have continued to decline, but these funds remain a structural vulnerability due to their susceptibility to runs. In December 2021, the Securities and Exchange Commission proposed reforms to MMFs, including the adoption of swing pricing for certain fund types, increased liquidity requirements, and other measures meant to make them more resilient to redemptions. The Russian invasion of Ukraine does not appear to have left a material imprint on broader short-term funding markets. Trading conditions in those markets have been stable, issuance continued, and spreads remained well below the levels reached in March 2020. Although depth in markets for Treasury securities and some commodity and equity derivatives has been low by historical standards, those markets have functioned normally after the initial shock to the nickel market. Elevated market volatility—particularly in commodity markets—caused central counterparties (CCPs) to make larger margin calls. To date, clearing members have been able to meet these margin calls, and, in general, CCPs effectively managed the increased risks and higher trading volumes.

The aggregate value of stablecoins—digital assets that aim to maintain a stable value relative to a national currency or other reference assets—grew rapidly over the past year to more than $180 billion in March 2022. The stablecoin sector remained highly concentrated, with the three largest stablecoin issuers—Tether, USD Coin, and Binance USD—constituting more than 80 percent of the total market value. The collapse in the value of certain stablecoins and recent strains experienced in markets for other digital assets demonstrate the fragility of such structures. More generally, stablecoins that are not backed by safe and sufficiently liquid assets and are not subject to appropriate regulatory standards create risks to investors and potentially to the financial system, including susceptibility to potentially destabilizing runs. These vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins. In addition, the increasing use of stablecoins to meet margin requirements for levered trading in other cryptocurrencies may amplify volatility in demand for stablecoins and heighten redemption risks. The President's Working Group on Financial Markets, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have made recommendations to address prudential risks posed by stablecoins.

A routine survey of market contacts on salient shocks to financial stability highlights several important risks. Stresses in Europe related to Russia's invasion of Ukraine or in emerging markets could spill over to the United States. In addition, higher or more persistent inflation and greater-than-expected increases in interest rates could negatively affect domestic economic activity, asset prices, credit quality, and financial conditions more generally. As concerns over cyber risk have increased, U.S. government agencies and their private-sector partners have been stepping up their efforts to protect the financial system and other critical infrastructures. These risks, if realized, could interact with financial vulnerabilities and pose additional risks to the U.S. financial system.

Invasion of Ukraine and Commodity Markets

Russia's invasion of Ukraine and subsequent international sanctions disrupted global trade in commodities, leading to surging prices and heightened volatility in agriculture, energy, and metals markets. These markets include spot and forward markets for physical commodities as well as futures, options, and swaps markets that involve an array of financial intermediaries and infrastructures. Stresses in financial markets linked to commodities could disrupt the efficient production, processing, and transportation of commodities by interfering with the ability of commodity producers, consumers, and traders to hedge risks. Such stresses can also increase liquidity and credit risks for financial institutions that are active in commodity markets. To date, however, financial market stresses do not appear to have exacerbated the negative effects on broader economic activity or created substantial pressure on key financial intermediaries, including banks. Since the invasion, for most commodities, futures trading volumes and open interest—the number of contracts outstanding at the end of the day—have remained in normal ranges.

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Markets for Treasury securities, mortgage-backed securities, corporate and municipal bonds, and equities generally functioned in an orderly way, but some measures of liquidity deteriorated

Liquidity conditions in the market for Treasury securities, which had deteriorated somewhat since late 2021, in part as a result of heightened interest rate risk, worsened further in late February following Russia's invasion of Ukraine. Market depth—a gauge of the ability to transact in large volumes at quotes posted by market makers—for Treasury securities fell and remains at historically low levels. Bid-ask spreads increased somewhat. However, trading volumes remained within normal ranges, suggesting that market functioning was not materially impaired. The decreases in depth were the greatest for bonds with shorter maturities because the prices of those securities are more sensitive to expectations for monetary policy over the near term. The market for MBS has functioned in an orderly way since late February, even as some measures of liquidity conditions deteriorated. Measures of market functioning in corporate and municipal bond markets indicated that the markets have remained liquid and trading conditions have stayed stable since late February without substantive disruptions around the time of Russia's invasion of Ukraine. Transaction costs in the corporate bond market and in the municipal bond market have both picked up somewhat since late February, and in the corporate bond market, bid-ask spreads are modestly above pre-pandemic levels. Transaction costs remain fairly low by historical standards. Liquidity in equity markets has declined since late 2021 in part because of rising uncertainty about the outlook for monetary policy as well as Russia's invasion of Ukraine and has remained at low levels since then. Market depth based on the S&P 500 futures is below pre-pandemic levels and currently in the bottom decile of its historical distribution since 2018.

Short-term funding market conditions remained stable...

Conditions in money markets have been stable and orderly. Increases in the target range for the federal funds rate fully passed through to market overnight rates. The effective federal funds rate and other unsecured overnight rates have been a few basis points below the interest rate on reserve balances since late February. The Secured Overnight Financing Rate has been at or below the offering rate at the overnight reverse repurchase agreement (ON RRP) facility, given ample liquidity and a limited supply of Treasury bills. Softness in repurchase agreement rates contributed to ongoing increases in ON RRP take-up, which reached an average of around $2.1 trillion per day in June. Russia's invasion of Ukraine does not appear to have left a material imprint in the broad U.S. dollar funding markets to date. In late February and early March, spreads on some longer-tenor commercial paper and negotiable certificates of deposit increased notably amid uncertainties around monetary policy tightening and Russia's invasion of Ukraine. These spreads have broadly narrowed since mid-March.

Weighted average maturities for money market funds (MMFs) stand at low levels, as MMFs tend to adjust their portfolios toward shorter-tenor instruments to position for rising interest rates around monetary policy tightening cycles.

Bank credit expanded in the first quarter amid strong loan demand

Strong loan growth pushed the ratio of bank credit to GDP higher in the first quarter (figure 38). The acceleration in growth was broad based, with balance growth accelerating for most major loan categories. Growth was particularly strong for commercial and industrial and credit card loans, for which demand continued to strengthen in the first quarter according to the April 2022 Senior Loan Officer Opinion Survey on Bank Lending Practices. More recently, loan growth moderated somewhat in May amid higher rates and a more uncertain economic outlook but remained strong. Bank profitability also remained strong but fell somewhat in the first quarter, in part as a result of declines in investment banking revenue and the fading boost to profitability from the release in previous quarters of loan loss reserves accumulated in 2020 (figure 39). Nevertheless, higher interest rates and strong loan demand are expected to support bank profitability in the near term. Delinquency rates on bank loans remained low.

International Developments

Economic activity continued to recover abroad...

Economic activity continued to recover in many foreign economies in the first quarter, albeit at a slower pace than last year's strong performance. The still-robust growth in many foreign economies reflected the recovery in many parts of the world from previous pandemic shocks amid progress on vaccinations and a greater ability to cope with outbreaks without extensive lockdowns. Moreover, unemployment rates in many advanced foreign economies (AFEs) continued to decline and are now below their pre-pandemic levels (figure 40).

More recently, headwinds from the war in Ukraine and COVID-19 lockdowns in China weighed on the foreign recovery. The slowing of activity has been particularly sharp in China, with recent indicators plunging amid COVID-related mobility restrictions. In Europe, recent indicators also show a sharp slowing, reflecting lower real incomes, reduced confidence of households and businesses in the economy, and continued supply chain disruptions.

...while foreign inflation remained on the rise in most economies...

As in the United States, inflation in many foreign economies has continued to rise. Soaring energy prices have remained a major driver of higher inflation in AFEs, and rising food prices accounted for most of the increase in inflation in emerging market economies (EMEs). Food and energy price rises have made up the bulk of the increase, though supply chain disruptions have contributed as well, and inflationary pressures have broadened as elevated input costs are increasingly passed through to prices of goods and services. (See the box "Global Inflation.")

Global Inflation

Over the past year, inflation increased rapidly in many foreign economies, reflecting soaring commodity prices, pandemic-related supply disruptions, and imbalances between demand for goods and services (figure A). More recently, the war in Ukraine and the renewals of COVID-19 lockdowns in China have amplified inflationary pressures, particularly through higher food and energy prices.

The recent surge in foreign inflation was mainly concentrated in volatile components, such as food and energy prices, with these components contributing much more to inflation in recent months than in pre-pandemic years (figure B). In particular, energy prices accounted for almost half of the 12-month headline inflation rate for the advanced foreign economies (AFEs) in April. Meanwhile, food prices are driving inflation in emerging market economies, largely due to the war and its threat to already fragile food security in these economies.

Price pressures have recently broadened to core inflation, as elevated input costs have been increasingly passed through to prices of goods and services that have not been directly affected by supply disruptions and soaring commodity prices. This broadening of inflationary pressure is reflected in increases in the share of categories of core goods and services prices rising more than 3 percent in most major AFEs (figure C). Furthermore, the rebalancing of demand away from goods toward services—which would have reduced upward pressures on prices of goods—has been slower than expected so far, contributing to the persistence of inflation pressures.

Persistent and widening price pressures are also evident in increases in market- and survey-based inflation expectations, although these expectations generally remain anchored in historical ranges (figure D). Even though such increases in inflation expectations might be a welcome development for economies such as Japan and the euro area that have experienced persistently below-target inflation in recent decades, many foreign central banks have been tightening monetary policy amid broadened price pressures and tight labor markets.

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...and many foreign central banks are tightening monetary policy

In response to elevated inflation and broadening price pressures, many AFE central banks increased policy rates, and some started to reduce the size of their balance sheets. Concerns over the persistence of inflationary pressures led several EME central banks, primarily those in Latin America, to raise their policy rates further. Several central banks in emerging Asia, where inflation had been more subdued but has recently begun to rise, also started to raise policy rates. (See the box "Monetary Policy in Foreign Economies.")

Monetary Policy in Foreign Economies

With inflation rising sharply across the globe, central banks have broadly shifted toward tighter monetary policy. Policy tightening started last year, as some emerging market central banks—particularly those in Latin America—increased policy rates out of concern that sharp increases in inflation could become entrenched in inflation expectations. Among the advanced foreign economies (AFEs), central banks of some smaller economies (New Zealand and Norway) with particularly strong recoveries were the first to hike their policy rates last autumn, while policy expectations for some major AFE central banks began to rise sharply (figure A).

Last December, the Bank of England (BOE) raised its policy rate from 0.1 percent to 0.25 percent, citing a strong labor market and rising inflation. This year, with U.K. inflation picking up more sharply, the BOE followed with additional rate hikes in subsequent meetings, taking its policy rate to 1 percent in May. The Bank of Canada (BOC) began raising its policy rate in March with a 25 basis point hike. In response to sharply higher inflation and the view that economic slack in the Canadian economy had been absorbed, the BOC followed with hikes of 50 basis points each in April and June, bringing the policy rate to 1.5 percent. As inflation concerns grew more widespread, the Reserve Bank of Australia (RBA) and the Swedish Riksbank pivoted sharply to hike rates in May, and the European Central Bank (ECB) recently stated that it intends to start raising its policy rate in July.

Supporting the overall thrust toward tighter global monetary policy, several AFE central banks that had expanded their balance sheets over the past two years are now allowing them to shrink. In recent months, the BOE, the BOC, the RBA, and the Swedish Riksbank have begun to shrink their balance sheets by stopping full reinvestments of maturing government bond holdings. The BOE has indicated that it will consider accelerating the pace of balance sheet reduction by selling U.K. government bonds; it will provide an update in August on a strategy for possible future bond sales. After tapering its purchases in recent months, the ECB announced it will end net asset purchases as of July 1.

Not all major foreign central banks have been tightening monetary policy. The Bank of Japan (BOJ) has maintained its overnight policy rate at negative 0.1 percent, given its outlook that Japanese inflation will remain subdued in the medium term. The BOJ also vowed to continue purchasing Japanese government bonds to defend its current yield curve control target band around 0 percent for the 10-year nominal yield. In addition, the People's Bank of China recently increased its monetary stimulus through reductions in reserve requirement ratios and some key benchmark interest rates amid a weakening of economic activity in China.

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Financial conditions abroad tightened since the beginning of the year...

As central banks raised interest rates or signaled that they would do so soon, market-based policy expectations and sovereign bond yields rose significantly in many AFEs (figure 41). The rise in sovereign bond yields reflects increases in both real yields, arising from less accommodative central bank communications, and inflation compensation. Since the start of the year, short- and medium-term inflation compensation measures in the euro area rose more than in many other AFEs, reflecting the region's larger exposure to the inflationary pressures stemming from Russia's invasion of Ukraine. Sovereign bond spreads over German bund yields for euro-area peripheral countries recently widened significantly. These moves partially retraced following an unscheduled meeting of the European Central Bank (ECB) on June 15, where the ECB indicated that it would take action to address potential fragmentation in euro-area sovereign bond markets.

Concerns about persistently high inflation and associated monetary policy tightening across countries, as well as Russia's invasion of Ukraine and COVID lockdowns in China, weighed on foreign risky asset prices (figure 42). Equities in many AFEs have declined since the beginning of the year. Equity declines were particularly strong in the euro area, given the region's trade and financial linkages to Russia and concerns over the possibility of the conflict spreading to other parts of Europe. Euro-area corporate bond spreads have widened since the beginning of the year and are well above their pre-pandemic levels.

Financial conditions in EMEs have tightened since the beginning of the year but are not particularly tight relative to historical norms. EME-dedicated funds have experienced net outflows so far this quarter, reversing the inflows in the first quarter of this year (figure 43). Outflows have been concentrated in Asia, especially China. Since Russia's invasion of Ukraine, investment funds that focus on emerging Europe have experienced particularly rapid outflows. EME sovereign bond spreads widened considerably. European emerging market equities and Chinese equities declined significantly, the latter amid COVID-related lockdowns and related supply chain constraints as well as continued regulatory uncertainty. Latin American equities, supported in part by rising commodity prices, declined by less than other emerging markets.

...and the dollar appreciated notably

Since the beginning of the year, the broad dollar index—a measure of the trade-weighted value of the dollar against foreign currencies—has risen notably amid safe-haven flows and increases in U.S. yields (figure 44). The dollar appreciated more against AFE currencies than EME currencies, as rising commodity prices supported Latin American currencies. The Chinese renminbi depreciated against the dollar amid growth concerns related to the lockdowns in China and weaker-than-expected Chinese data releases. Among AFE currencies, the dollar appreciated particularly strongly against the Japanese yen, largely reflecting the widening U.S.–Japanese yield differential.


 2. The Bureau of Labor Statistics incorporated new population estimates beginning with the January 2022 employment report. This development resulted in a one-time jump in the estimate of the aggregate LFPR of about 0.3 percentage point due to a change in the age distribution of the population. Accordingly, the 0.4 percentage point increase in the published measure from December to May overstates the improvement in the LFPR by about 0.3 percentage point. Return to text

 3. This shortfall in the LFPR corresponds to a shortfall in the labor force of about 2.8 million persons. (This calculation holds the LFPR constant at its February 2020 level and assumes population growth equal to the actual growth observed since February 2020.)  Return to text

 4. Population forecasts just before the onset of the pandemic also projected faster population growth for 2021–22 than has been realized. For example, the Congressional Budget Office projected 0.8 percent growth per year in 2021–22 in its January 2020 budget and economic projections; see Congressional Budget Office (2020), The Budget and Economic Outlook: 2020 to 2030 (Washington: CBO, January), Before 2015, population growth was even higher. For example, the average growth rate in the working-age population between 1980 and 2014 was 1.2 percent per year. Return to text

 5. The effect of COVID-related deaths on the labor force, however, was relatively smaller, because these deaths have been concentrated among older individuals, who tend to have low LFPRs. Return to text

 6. This calculation uses the actual LFPR in May 2022 and multiplies it by the level of the population that would have been realized in that month had population growth over 2020–21 been the same as the growth observed over 2015–19. Return to text

 7. After adjusting for population growth since the beginning of the pandemic, the shortfall in payrolls relative to their pre-pandemic level was about 2.3 million in May. Return to text

 8. The labor force includes all people aged 16 and older who are classified as either employed or unemployed. Return to text

 9. Another usual indicator of the gap between available jobs and available workers is the ratio of job openings to unemployment. At the end of April, this indicator showed that there were 1.9 job openings per unemployed person. Return to text

 10. The November 2021 Beige Book reported that many employers were planning to increase hiring because of concerns that their current workforce was being overworked. Return to text

 11. For more information, see Congressional Budget Office (2020), "The Budgetary Effects of Laws Enacted in Response to the 2020 Coronavirus Pandemic, March and April 2020," June,; Congressional Budget Office (2021), "The Budgetary Effects of Major Laws Enacted in Response to the 2020–21 Coronavirus Pandemic, December 2020 and March 2021," September,; and Congressional Budget Office (2021), "Senate Amendment 2137 to H.R. 3684, the Infrastructure Investment and Jobs Act, as Proposed on August 1, 2021," August 9, to text

 12. The results of the Survey of Primary Dealers and the Survey of Market Participants are available on the Federal Reserve Bank of New York's website at and, respectively. Return to text

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Last Update: August 11, 2022