Board of Governors of the Federal Reserve System

Part 1: Recent Economic and Financial Developments

Monetary Policy Report submitted to the Congress on March 1, 2024, pursuant to section 2B of the Federal Reserve Act

Domestic Developments

Inflation has eased but remains elevated

After surging in 2021 and 2022, inflation slowed notably last year. The price index for personal consumption expenditures (PCE) rose 2.4 percent over the 12 months ending in January, down from a peak of 7.1 percent in 2022, though still above the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent (figure 1). The core PCE price index—which excludes volatile food and energy prices—rose 2.8 percent over the 12 months ending in January. More recently, core PCE prices increased at an annual rate of 2.5 percent over the six months ending in January, though measuring inflation over relatively short periods risks exaggerating the influence of idiosyncratic or temporary factors (figure 2). The trimmed mean measure of PCE prices constructed by the Federal Reserve Bank of Dallas—which provides an alternative approach to reducing the influence of idiosyncratic price movements—increased 3.3 percent over the 12 months ending in December, somewhat higher than the core index (figure 1).

Consumer energy prices have declined, while food price inflation has slowed markedly

After hovering around $80 per barrel in the first half of last year, oil prices rose notably in late summer, albeit to levels still well below those seen in 2022, but have since declined, on net, to around $83 per barrel (figure 3). Gasoline prices have followed a similar pattern. The moderation in oil prices last fall reflects weak economic activity abroad and increases in U.S. and other non-OPEC (Organization of the Petroleum Exporting Countries) oil production. Since late last year, geopolitical tensions in the Middle East and rerouting of shipping away from the Red Sea have placed some upward pressure on oil prices. Continuing geopolitical tensions pose an upside risk to energy prices. Natural gas prices remain well below the elevated 2022 levels due to strong production and high inventory levels. All told, consumer energy prices fell 4.9 percent in the 12 months ending in January (figure 4, left panel).

Food price inflation slowed markedly last year, as prices of agricultural commodities and livestock fell (figure 5). This moderation brought the 12-month change in food prices down to 1.4 percent in January, a substantial slowing from the 11 percent increase recorded over 2022 (figure 4, left panel).

Prices of both energy and food products are of particular importance for lower-income households, for which such necessities account for a large share of expenditures. Reflecting the sharp increases seen in 2021 and 2022, these price indexes are about 25 percent higher than before the pandemic.

Core goods prices have been declining as supply bottlenecks ease and import price inflation falls...

Outside of food and energy prices, there has been significant deceleration across the main spending categories, though disinflation has been more pronounced in some than in others (figure 4, right panel). Core goods prices fell 0.6 percent in the 12 months ending in January, and the deceleration was broad based, as the supply chain issues and other capacity constraints that had earlier boosted inflation so much eased substantially. For example, suppliers' delivery times had lengthened considerably during the pandemic but have been getting shorter over the past year (figure 6). Core goods inflation was also held down last year by a net decline in nonfuel import prices, which, in turn, largely reflected falling commodity prices (figure 7).

...while core services price inflation has been slowing but remains elevated

Price inflation for both housing services and core services other than housing slowed over the past year, though it remains elevated. Increases in housing services prices began to moderate, coming in at 6.1 percent in the 12 months ending in January, down from a peak of more than 8 percent (figure 4, right panel). This slowing is consistent with the notably smaller increases in market rents on new housing leases to new tenants seen since late 2022 (figure 8). Because prices for housing services measure the rents paid by all tenants (and the equivalent rent implicitly paid by all homeowners)—including those whose leases have not yet come up for renewal—they tend to adjust slowly to changes in rental market conditions. The softening in market rents therefore points to a continued deceleration in housing services prices over the year ahead.

Prices for nonhousing core services—a broad group that includes services such as travel and dining, financial services, and car repair—rose 3.5 percent in the 12 months ending in January, down from their recent peak of 5.2 percent (figure 4, right panel). As labor costs are a significant input in these service sectors, the ongoing softening of labor demand and improvements in labor supply should contribute to a further slowing in core services price inflation as labor cost growth moderates.

Measures of longer-term inflation expectations have been stable, while shorter-term expectations have fallen back

The generally held view among economists and policy analysts is that inflation expectations influence actual inflation by affecting wage- and price-setting decisions. Survey-based measures of expected inflation over a longer horizon have generally been moving sideways over the past year, within the range seen during the decade before the pandemic, and they appear broadly consistent with the FOMC's longer-run 2 percent inflation objective. This development is seen for surveys of households, such as the University of Michigan Surveys of Consumers, and for surveys of professional forecasters (figure 9). For example, the median forecaster in the Survey of Professional Forecasters, conducted by the Federal Reserve Bank of Philadelphia, continued to expect PCE price inflation to average 2 percent over the five years beginning five years from now.

Moreover, inflation expectations over a shorter horizon—which tend to follow observed inflation more closely—have been reversing their earlier run-ups. In the Michigan survey, the median value for inflation expectations over the next year was 3.0 percent in February, well below the peak rate of 5.4 percent observed in spring 2022. Expected inflation for the next year as measured in the Survey of Consumer Expectations, conducted by the Federal Reserve Bank of New York, has also declined, on net, over this period and has returned to the range of values seen before the pandemic.

Market-based measures of longer-term inflation compensation, which are based on financial instruments linked to inflation such as Treasury Inflation-Protected Securities, are also broadly in line with readings seen in the years before the pandemic and consistent with inflation returning to 2 percent. These measures have been little changed, on net, since last summer (figure 10).

The labor market remains strong

Payroll employment gains have been robust, averaging 239,000 since June of last year. The pace of job gains has nevertheless been softening, having averaged more than 375,000 per month in 2022 and about 290,000 in the first half of 2023 (figure 11). This slowing has come primarily from the professional and business services, manufacturing, and leisure and hospitality sectors, which tend to be cyclically sensitive. In contrast, employment growth has remained strong in the health-care and social assistance sector and at state and local governments, which tend to be less cyclically sensitive and are still recovering from pandemic-era staffing shortages.

The unemployment rate edged up, on net, since the middle of last year, but at 3.7 percent in January, it is only slightly above its pre-pandemic level and remains very low by historical standards (figure 12). Indeed, unemployment rates among most age, educational attainment, sex, and ethnic and racial groups are near their respective historical lows (figure 13). (The box "Employment and Earnings across Demographic Groups" provides further details.)

Labor demand has been gradually cooling...

Demand for labor continued to cool last year but remains robust. The Job Openings and Labor Turnover Survey (JOLTS) indicated that there were nearly 9 million job openings at the end of 2023—down about 3 million from the all-time high recorded in March 2022 but still around 2 million above pre-pandemic levels. An alternative measure of job vacancies constructed by the Federal Reserve Board staff using job postings data from the large online job board Indeed also shows that vacancies continued to move gradually lower through mid-February but remained above pre-pandemic levels. In addition, measures of layoffs, such as initial claims for unemployment insurance and the rate of layoffs and discharges in the JOLTS, have remained very low by historical standards.

...and labor supply has increased further...

Meanwhile, the supply of labor has continued to increase on net. The labor force participation rate, which measures the share of people either working or actively seeking work, continued to trend higher for most of last year but has softened in recent months (figure 14). Importantly, labor force participation for prime-age workers increased notably through last September and, although it has edged down more recently, remains above its pre-pandemic level.

Labor supply was also boosted last year by relatively strong population growth. The Census Bureau estimates that the resident population increased 1.7 million (0.5 percent) in 2023, with almost 70 percent of that increase coming from immigration.² Last year's rate of population growth was slightly faster than in 2022 and about twice as fast as in 2020 and 2021, when growth was held down by COVID-19-related increases in mortality and restrictions on immigration. Although population growth has largely returned to its pace from the years preceding the pandemic, it remains well below its average from 1990 to 2015.

...but the labor market remains relatively tight

Even with easing labor demand and rising labor supply, the labor market remains relatively tight. Some indicators suggest that the labor market remains tighter than before the pandemic, while others have returned to their 2019 ranges, when the labor market was also relatively tight. The number of total available jobs (measured by employed workers plus job openings) still exceeds the number of available workers (measured by the labor force). This jobs–workers gap was around 2.8 million in December, down markedly from its peak of 6.0 million recorded in March 2022 but still above its 2019 average of 1.1 million (figure 15).³ In contrast, the percentage of workers quitting their jobs each month, an indicator of the availability of attractive job prospects, was 2.2 percent in December, close to its 2019 average. Surveys indicate that households' and small businesses' perceptions of labor market tightness have also come down from their recent peaks. In addition, business contacts in nearly all Federal Reserve Districts cited signs of a cooling labor market, such as larger applicant pools and lower turnover rates; however, some employers continued to report difficulty finding workers, particularly employers seeking specialized skills.⁴

Wage growth has slowed but remains elevated

Consistent with the easing in labor market tightness, nominal wage growth slowed in 2023 but remains elevated (figure 16). Total hourly compensation as measured by the employment cost index increased 4.2 percent over the 12 months ending in December, a noticeable slowing from the 5.1 percent increase in 2022. Other aggregate measures, such as average hourly earnings (a less comprehensive measure of compensation) and the Federal Reserve Bank of Atlanta's Wage Growth Tracker, which reports the median 12-month wage growth of individuals responding to the Current Population Survey, have slowed as well. With PCE prices having risen 2.6 percent in 2023, these measures suggest that most workers saw increases in the purchasing power of their wages over the past year.

Labor productivity strengthened last year

The extent to which nominal wage gains raise firms' costs and act as a source of inflation pressure depends importantly on the pace of productivity growth. Labor productivity in the business sector has been extremely variable since the pandemic began, increasing sharply in 2020 and then declining, on average, over 2021 and 2022 (figure 17). Productivity is reported to have risen a robust 2.7 percent last year. When averaged over the pandemic period, output per hour rose at a moderate average annual rate of 1-1/2 percent, in line with the average rate of growth observed during the business cycle from the fourth quarter of 2007 to the fourth quarter of 2019.

As always, the pace of future productivity growth remains highly uncertain. It is possible that productivity growth could remain at around this same moderate pace. However, it is also possible that the rapid adoption of new technologies like artificial intelligence and robotics—as well as the high rate of new business formation that the pandemic brought about—could boost productivity growth above that pace in coming years.

Gross domestic product rose at a solid pace last year

Real gross domestic product (GDP) is reported to have increased at an annual rate of 4.0 percent in the second half of 2023, up from 2.2 percent in the first half. For 2023 as a whole, GDP increased 3.1 percent, notably faster than in 2022 despite restrictive financial conditions, including elevated longer-term interest rates (figure 18).⁵ Among the components of GDP, consumer spending rose solidly in the second half of last year, and residential investment started to turn back up following its earlier sharp declines, but growth of business investment slowed.

In contrast to GDP, manufacturing output was little changed, on net, last year, a downshift following two years of robust post-pandemic gains. Motor vehicle production continued to rebound from supply chain disruptions in 2021 and 2022, although last year's production was held down by strikes at several major automakers. Outside of motor vehicles, industrial production generally moved sideways last year, but it was down from its post-pandemic peak in early 2022, as inventories normalized and new orders fell back.

Consumer spending growth was resilient even as household finances deteriorated

Consumer spending adjusted for inflation grew at a solid rate of 3.0 percent in the second half of 2023 and 2.7 percent for last year as a whole (figure 19). Consumers' resilience in the face of tight financial conditions was supported by the strong labor market and rising real incomes. Indeed, after declining, on average, in 2021 and 2022, real disposable personal income increased robustly last year. However, last year's spending was also accompanied by households drawing down their liquid assets, such as checking accounts, and by relying more on credit. Indeed, the saving rate was 3.9 percent in the fourth quarter of 2023, well below pre-pandemic levels (figure 20). In addition, although household wealth relative to income remains high in the aggregate, it has declined, on net, since the end of 2021 and so is likely providing less support to consumer spending. Consumer spending since the pandemic has been more robust than measures of consumer sentiment would suggest. Although sentiment in the Michigan survey has improved markedly in recent months, it remains much further below its pre-pandemic level than does a similar measure from the Conference Board, which puts more weight on labor market conditions (figure 21).

Consumer financing conditions tightened last year

Credit remains available for most consumers, though interest rates on both credit cards and auto loans remain higher than the levels observed in 2018 at the peak of the previous monetary policy tightening cycle. Indeed, interest rates on credit cards have continued to increase since the first half of last year. In addition, banks reported continued tightening of lending standards across consumer credit products, in part reflecting lenders' concerns about further deterioration in credit performance and higher funding costs. Delinquency rates for credit cards rose further over the second half of 2023, while those for auto loans flattened out; both rates are notably above levels observed just before the pandemic. Reflecting these and other factors, consumer credit expanded moderately during the second half of last year, driven by robust growth in credit card balances and modest growth in auto loans (figure 22). In contrast, student loan balances fell in the second half of last year, in large part driven by the cancellation of debt for certain borrowers in income-driven repayment plans.

Residential investment turned around and grew modestly in the second half of 2023

After declining steeply in 2022 on the heels of the substantial rise in mortgage interest rates, residential investment fell a bit further in the first half of 2023 but picked up in the second half of the year. The pickup in housing activity since mid-2023 masked some important differences across components of the market, with sales of existing homes much weaker than sales of new homes and with construction of single-family homes remaining relatively solid while multifamily construction declined. (The box "Recent Housing Market Developments" provides further discussion.)

Capital spending growth softened amid tighter financial conditions and subdued sentiment

Tighter financial conditions and downbeat business sentiment led to a slowdown in business investment spending growth in the second half of 2023 (figure 23). Equipment investment spending declined in the second half of the year, while investment in intellectual property products—which include software and research and development—continued to decelerate from its solid pace of growth over the previous few years. Investment in nonresidential structures, which had surged in early 2023 because of a boom in manufacturing construction—especially for factories that produce semiconductors or electric vehicle batteries—also decelerated in the second half of 2023, although the level of structures investment remained much higher than in previous years. Although indicators of business sentiment and profit expectations have improved in recent months, sentiment remains subdued.

Business financing conditions were moderately restrictive overall, but credit remained generally available

Credit remained generally available to most nonfinancial corporations but at elevated interest rates and amid moderately restrictive financial conditions overall. Banks continued to tighten lending standards for all loan types over the second half of last year, and business loan growth at banks continued to slow. In contrast, issuance of corporate bonds remained solid across credit categories, although well below the levels prevailing at the beginning of the tightening cycle.

For small businesses, which are more reliant on bank financing than large businesses, credit conditions tightened further over the second half of last year. Surveys indicate that credit supply for small businesses has tightened further, and interest rates on loans to small businesses moved higher and now stand near the top of the range observed since 2008. Loan default and delinquency rates have also increased and now slightly exceed their pre-pandemic rates.

Trade recovered in the second half of 2023

Real imports remained relatively unchanged for the year as a whole after declining in the first half of last year and then recovering over the second half as domestic demand picked up (figure 24). Despite lackluster foreign growth, exports picked up more strongly than imports over the second half of the year. As such, net exports added about 0.3 percentage point to GDP growth in the fourth quarter of 2023 after being neutral for growth in the previous two quarters. The current account deficit narrowed slightly in the third quarter of 2023 to 2.9 percent of GDP, remaining larger than before the pandemic.

Federal fiscal policy actions were roughly neutral for GDP growth in 2023

Federal purchases grew modestly in 2023, and several recently enacted policies began to boost investment and consumption. This support to economic activity was about offset by the unwinding of the remaining pandemic-related fiscal policy support. All told, the contribution of discretionary changes in federal fiscal policy to real GDP growth was roughly neutral last year.

The budget deficit and federal debt remain elevated

After surging to 15 percent of GDP in fiscal year 2020, the budget deficit declined through 2022 as the imprint of the pandemic faded (figure 25). The budget deficit edged up to 6.3 percent of GDP in fiscal 2023 as tax receipts declined from their elevated level in 2022 and net interest outlays increased.⁶

As a result of the unprecedented fiscal support enacted early in the pandemic, federal debt held by the public jumped roughly 20 percentage points to 100 percent of GDP in fiscal 2020—the highest debt-to-GDP ratio since 1947 (figure 26). After falling slightly through 2022, the debt-to-GDP ratio edged up in 2023, as rising interest rates contributed to higher net interest outlays. The Congressional Budget Office projects that further increases in interest costs, along with positive primary deficits—that is, total deficits less interest payments—will produce a steady rise in the debt-to-GDP ratio in the years to come.

Most state and local government budget positions remained strong...

Federal policymakers provided a historically high level of fiscal support to state and local governments during the pandemic; this aid, together with robust state tax collections in 2021 and 2022, left the sector in a strong budget position overall (figure 27). Although state tax revenues weakened in 2023—mainly reflecting a normalization of receipts from elevated levels in the previous year as well as the effects of recently enacted tax cuts in some states—taxes as a percentage of GDP remained above recent historical norms. Moreover, states' total balances (that is, including rainy day fund balances and previous-year surplus funds) continued to be near all-time highs. Nevertheless, budget situations varied widely across the states, with some states—particularly those that depend heavily on capital gains tax collections—facing tighter budget conditions. At the local level, overall property tax receipts rose briskly in 2023.

...contributing to brisk growth in employment and construction spending

Employment in state and local governments rose strongly in 2023, as some pandemic-related headwinds, such as an increase in retirements, have abated and wages became more competitive relative to those in the private sector (figure 28). Similarly, real construction outlays grew rapidly, reflecting easing bottlenecks and support from federal grants. By the end of 2023, both employment and construction spending were roughly back to their pre-pandemic levels.

Financial Developments

The expected level of the federal funds rate over the next few years is now higher than it was last June on net

Market-based measures of the expected federal funds rate rose considerably over the summer and early fall before moving down toward the end of 2023. On net, the market-implied policy rate path rose notably for year-end 2024, and somewhat more modestly for year-end 2025 and 2026 (figure 29).⁷ Financial market prices imply that the federal funds rate will decline from current levels following the March 2024 FOMC meeting, reaching about 4.6 percent and about 3.7 percent by year-end 2024 and year-end 2025, respectively. Consistent with these market-implied measures, survey respondents in the Blue Chip Financial Forecasts published at the beginning of February expect the policy rate to begin to decrease in the second quarter of 2024 and reach 4.4 percent by year-end 2024. On net, respondents have significantly revised upward their expectations of the federal funds rate path since last June's survey.

Yields on long-term U.S. nominal Treasury securities fluctuated considerably

Yields on long-term nominal Treasury securities began to increase in the spring of 2023 and rose markedly through mid-October before reversing course sharply, with the 10‑year Treasury yield reaching a peak of about 5 percent before falling to just below 4 percent by the end of last year (figure 30). So far this year, long-term nominal Treasury yields have increased, with the 10-year Treasury yield rising to about 4.4 percent by late February. In contrast, short-term Treasury yields have been little changed, on net, since early June.

Yields on other long-term debt fluctuated with Treasury yields

Corporate bond yields declined across credit categories since June, on net, amid sizable fluctuations that accompanied the observed large movements in long-term Treasury yields (figure 31). Spreads on corporate bonds over comparable-maturity Treasury securities narrowed notably, on net, especially for speculative-grade bonds, to levels in the lower range of their historical distributions. Similarly, municipal bond spreads over comparable-maturity Treasury securities narrowed substantially since June and are now fairly low relative to their historical distributions across credit ratings. Overall, corporate and municipal credit quality remained solid, with a low volume of defaults in both markets despite some increase in corporate bond defaults.

Yields on agency mortgage-backed securities (MBS)—an important pricing factor for home mortgage interest rates—rose notably over the summer before falling back down toward the end of last year (figure 32). So far this year, yields on agency MBS have increased, standing in late February at levels notably above those in June 2023. The MBS spread decreased slightly since June, on net, but remained elevated relative to pre-pandemic levels, at least partly due to high interest rate volatility, which reduces the value of holding MBS.

Broad equity price indexes increased

The S&P 500 index increased significantly since June, on net, above the record-high levels seen at the end of 2021 (figure 33). Following a substantial decline over late summer and early fall, the S&P 500 index recovered toward the end of the year, as long-term interest rates declined, and continued to rise over the start of 2024. Meanwhile, small-cap firms, whose equity prices have significantly underperformed broad equity indexes, experienced substantial increases in their equity valuations in recent months amid better economic prospects, including expectations of a less restrictive monetary policy. Bank equity prices rose, on net, retracing some of the declines that had occurred over the first half of 2023 and that had been associated with strains in the banking sector. In the case of the largest banks, equity prices rose above their early-2023 levels; regional bank equity prices had only a partial retracement. One-month option-implied volatility on the S&P 500 index—the VIX—increased moderately until late October but subsequently declined to reach levels somewhat lower than those prevailing in early June. (For a discussion of financial stability issues, see the box "Developments Related to Financial Stability.")

Major asset markets functioned in an orderly way, but liquidity has remained low

Treasury securities market functioning has continued to be orderly, but liquidity remained low by historical standards. The persistence of low liquidity is broadly in line with enduring high interest rate volatility, as future economic conditions and the policy rate path remain particularly uncertain. Market depth—a measure of the availability of contracts at the best quoted prices—for Treasury securities remains near historically low levels, particularly in the case of short-term Treasury securities. With regard to liquidity in the equity market, market depth based on S&P 500 futures was little changed and remained somewhat low compared with pre-COVID levels. Corporate and municipal secondary bond markets continued to function well; transaction costs in these markets were fairly low by historical standards.

Short-term funding market conditions remained stable

Conditions in overnight bank funding and repurchase agreement (repo) markets remained stable. Since June, the effective federal funds rate and other unsecured overnight rates have been a few basis points below the interest rate on reserve balances, while the Secured Overnight Financing Rate has been at or slightly above the offering rate on the overnight reverse repurchase agreement (ON RRP) facility. Take-up at the ON RRP facility has declined substantially since June. This decline reflects a significant increase in the net supply of Treasury bills and relatively more attractive rates on alternative short-term investments such as private repo.

Money market funds (MMFs), the largest investors in the ON RRP facility, accounted for much of the decline in ON RRP take-up as they made a substantial reallocation of their investments toward Treasury bills and private repo. Both prime and government MMFs have seen a notable increase in assets under management since June, as relatively favorable yields continue to attract funds previously held on deposit in the banking sector. Weighted average maturities at both prime and government MMFs increased in anticipation of fewer policy rate increases.

Bank credit growth continued to slow over the second half of 2023

The slowdown in bank credit growth was broad based, with growth in outstanding balances for all major loan categories slowing from earlier in the year, likely reflecting the effects of higher interest rates, tighter credit availability, and economic uncertainty (figure 34). Banks in the Senior Loan Officer Opinion Survey on Bank Lending Practices reported tighter standards and weaker demand over the third and fourth quarters, continuing trends for standards and demand that have been reported since the middle of 2022. Delinquency rates on bank loans generally rose in the second half of 2023—with the largest increases for commercial real estate and consumer loans—but remained around ranges observed before the pandemic except for consumer loans. Bank profitability moved down in the second half of 2023 to levels below those that prevailed before the pandemic (figure 35).

International Developments

Foreign economic growth slowed in the second half of 2023

Following a rebound in early 2023, foreign activity was subdued overall in the second half of last year, although with some variation across countries. In advanced foreign economies (AFEs), several factors restrained growth, including the tightening of monetary policy over the past two years—which weighed on credit growth and investment—and an erosion of real household incomes amid high inflation rates. In Europe, ongoing structural adjustment to higher energy prices also continued to hinder the performance of energy-intensive sectors. Economic indicators point to continued weakness in AFE growth in early 2024.

In China, a post-pandemic boost to economic growth early in 2023 faded by the second quarter, and property-sector weakness and sluggish domestic demand have remained a constraint on economic activity. Policy stimulus targeting infrastructure and manufacturing investment bolstered Chinese growth in the second half of the year, enabling the government to meet its 2023 growth target.

In emerging market economies (EMEs) other than China, economic activity slowed in the second half of last year but was more resilient overall than in the AFEs. Industrial production in emerging Asia excluding China began recovering, supported by a rebound in global demand for high-tech products that was driven in part by the artificial intelligence and electric vehicle sectors.

Inflation abroad has continued to ease but remains elevated

Foreign headline inflation has continued to decline since the middle of last year, reflecting lower core and food inflation (figure 36). Both the subsiding effects of past global supply bottlenecks and the drag on demand from monetary policy tightening have eased inflationary pressures (figure 37). However, the pace of disinflation has varied across sectors and countries. The deceleration in goods prices abroad has generally outpaced that in services prices, as in the U.S. Inflation remains above target in Europe but has been running near zero in China. Although the flare-up in geopolitical tensions in the Middle East and accompanying disruptions to shipping through the Red Sea have had only limited effects on consumer prices in general and on global energy prices in particular, further escalation in tensions could disrupt global momentum toward restoring lower inflation.

Foreign central banks are maintaining a restrictive monetary policy stance

Most foreign central banks paused their interest rate hikes in the second half of last year and have since held policy rates steady, acknowledging the cumulative tightening of policy and progress in lowering inflation. Policy rate paths implied by financial market pricing suggest that many AFE central banks are expected to begin reducing interest rates in 2024. Several EME central banks have already begun easing monetary policy. However, foreign central banks have generally continued to emphasize in their communications that progress toward achieving their inflation goals could slow or even reverse, including from resilience in labor markets, wage growth, or geopolitical developments leading to higher commodity prices and trade costs.

Financial conditions abroad have been volatile but have eased, on balance, since mid-2023

Near-dated AFE sovereign yields declined toward the end of last year as central banks signaled they had reached or neared the end of policy rate tightening. Longer-term sovereign yields unwound most of the increase registered earlier in 2023 (figure 38). One exception was Japan, where the central bank widened the band around its yield curve control target, allowing yields on 10-year government securities to increase, on net, in 2023.

Since mid-2023, the broad dollar index—a measure of the exchange value of the dollar against a trade-weighted basket of foreign currencies—increased slightly on net (figure 39). The dollar index was volatile, increasing significantly as U.S. yields rose from July to October and then reversing most of these increases as U.S. yields declined.

Many major foreign equity indexes rose across AFEs and EMEs, although gains were near zero in the U.K., consistent with stagnant economic activity (figure 40). Chinese equity prices were an exception, with declines amid pessimism about growth prospects and a pullback by foreign investors from Chinese markets. Flows to EME-focused investment funds turned negative in mid-2023, as yields on advanced-economy bonds rose more than those in emerging economies. These outflows eased toward the end of the year as AFE yields fell. EME sovereign spreads narrowed moderately last year.

Footnotes