On Friday, the Federal Reserve's semi-annual monetary policy report said that inflationary pressures in the United States are easing and the job market has returned to its pre-pandemic state, tight but not overheated. The financial system remains healthy and resilient, but there are signs of vulnerability.

Inflation will gradually decrease

Further progress this year has been muted and still above the FOMC's long-term target of 2%, despite the slowdown in personal consumption expenditures price inflation (PCE) since its highs, especially last year, the report said.

Previously released data showed that United States PCE rose 2.6% year-on-year in May, down from 4% in the same period last year and peaked 7.1% in June 2022. Core PCE, which excludes food and energy prices, rose 2.6% year-over-year, also down from 4.7% in the year-ago quarter.

The Fed believes that the continued rise in core goods price inflation and housing services prices eased in the first half of the year, while core non-housing services price inflation leveled off after a significant slowdown last year. Long-term inflation expectations continue to be broadly in line with the FOMC's long-term target of 2%.

The issue of house rents was mentioned in the report. The PCE Price Housing Services Index began to accelerate in 2021, with its contribution significantly increasing core PCE inflation. With changes in new and existing tenants often lagging changes in market rent indicators for new leases, the Fed said PCE housing services inflation should gradually decline, but there is still a lot of uncertainty about the extent.

Labor demand has eased

According to the report, the United States labor market continued to evolve and remained strong despite a gradual rebalancing in the first half of the year. Employment growth was stable, with an average of 248,000 non-farm payrolls in the first five months. Unemployment remains low.

However, the demand for labor has eased, with job vacancies reduced in many industries and a continued supply of migrant labor. The unemployment rate edged up to 4.0% in May as demand cooled further and labor supply increased, with the relationship between labor supply and demand gradually resembling the pre-pandemic period. At that time, the labor market was relatively tight, but not overheated.

Nominal wage growth continued to slow in the first half of the year and remained above the pace consistent with 2% inflation, given productivity growth.

Reduced holdings of government bonds and institutional securities

The Fed is methodically reducing its holdings of Treasuries and agency securities, and has reduced its balance sheet holdings by about $1.7 trillion since June 2022. The Federal Open Market Committee (FOMC) said its goal is to keep securities holdings consistent with effective monetary policy execution, ensuring a smooth transition from ample reserves to adequate reserve balances. Since early June, the Fed has slowed the pace of balance sheet reduction, planning to halt the process when reserve balances are slightly above what the committee considers adequate.

Since July 2023, the Fed has kept interest rates between 5% and 5.25%, which the FOMC believes will help move towards a better balance between employment and inflation targets. However, until there is sufficient confidence that inflation can continue to return to the 2% target, lowering the target rate range is not appropriate. Premature or excessive easing of policy could lead to a reversal of inflationary progress; And if the relaxation is insufficient, it could hurt the economy and employment. Therefore, in considering any policy adjustments, the Committee will carefully assess the latest data, changes in the economic outlook and the balance of risks.

The Fed reaffirmed its strong commitment to returning inflation to its 2% target, remains highly alert to the challenges posed by high inflation, and deeply understands the difficulties it causes to the economy. In its future decision-making, the Fed will continue to be cautious in ensuring that the policy path serves both economic growth and price stability in order to fulfill its dual mission.

From banking activity to monetary policy independence

An overview of financial stability shows that there appears to be some tightening in the current financial environment, with banks appearing to be relatively modest in lending activity. While some banks' commercial real estate portfolios are under pressure, the financial system remains solid and resilient overall. Liquidity remains healthy for most domestic United States banks.

Equity markets have risen faster than earnings expectations, while corporate bond yield spreads are near historic lows. It is worth noting that the unrealized losses on fixed income bonds of some banks remain significant. Hedge fund leverage climbed to an all-time high, largely driven by increased borrowing by large hedge funds.

With regard to the independence of monetary policy, the report notes that this fundamental principle has gained widespread acceptance and has become a universal standard worldwide. The study found that when central banks enjoyed independence, economies generally performed better. The United States Congress has set the long-term goal of monetary policy – to maximize employment and price stability – and has given the Fed the authority to operate independently to implement monetary policy. Under this framework, the Fed autonomously determines the most appropriate monetary policy actions to achieve its dual mission objectives.

In short, while financial markets have faced some challenges, such as a slowdown in lending activity and pressure in specific sectors, the financial system has remained robust overall. At the same time, monetary policy independence is seen as a key factor in economic stability and growth, and the role of the Fed in this regard is fully recognized and guaranteed.