Federal Reserve data showed that the Federal Reserve’s losses have topped $100 billion and are likely to rise much further before the red numbers end.
Central bank data released Thursday showed the Federal Reserve’s losses have topped $100 billion and are likely to rise much further before the red numbers end.
The Federal Reserve continues to pay more in interest costs than it receives from the interest it receives on the bonds it holds and on the services it provides to the financial sector. Although there is considerable uncertainty about how things will play out, some observers believe the Fed’s losses, which began a year ago, could double before easing.
William English, a former top central bank official now at Yale University, said he expects a “maximum” loss of about $200 billion by 2025. Meanwhile, Derek Tang of forecasting firm LH Meyer said the loss would likely be between $150 billion and $200 billion. billion for next year.
The Federal Reserve records its losses in a so-called deferred asset, an accounting measure that indicates what it will ultimately need to cover in the future before it can return to its normal practice of returning its profits to the Treasury. Losses of money are very rare for the Federal Reserve. However, at the same time, the Central Bank has repeatedly warned that the situation does not in any way affect its ability to conduct monetary policy and achieve its goals.
The Federal Reserve’s loss of money was no surprise given its aggressive campaign to raise interest rates, which pushed the benchmark interest rate up by one day from near zero in March 2022 to the current range of 5.25% to 5.50%. With inflationary pressures easing, it is widely believed that the Federal Reserve has ended its rate hikes or is close to doing so.
But that doesn’t mean that losses won’t continue to rise, because the current level of short-term interest rates will result in negative net income for a longer period of time. Instead, the losses will eventually stop, largely due to the Federal Reserve’s continued reduction in its balance sheet to complement its rate hikes.
The Federal Reserve has been buying bonds aggressively during the coronavirus pandemic and its immediate fallout, selling about $1 trillion in Treasury and mortgage bonds last year alone. Federal Reserve officials have suggested that there is more work to be done on this front, and as a result the central bank will have to spend less on interest rates by draining liquidity from the financial system. The financial markets expect a stop in the second or third quarter of 2024.
The liquidity sought by the Fed comes primarily in the form of bank reserves and inflows into the central bank’s reverse repurchase facility. Through these tools, the Fed pays a combination of banks, money managers, and others to hold cash on its books, so that when liquidity dwindles, it costs the central bank less to tie up the remaining funds, even if your federal funds rate doesn’t change.
“The pace of losses will slow even if interest rates remain high as reserves and (reverse repurchase agreements) decline as securities deplete and new asset purchases lead to new higher interest rates,” English said. But he acknowledged that “this is all very difficult,” given the multitude of factors and uncertainties at play.
Bank reserves have fallen by about $1 trillion since their peak in late 2021 and stood at $3.3 trillion as of Wednesday. Meanwhile, the daily live level of reverse repos has fallen from more than $2 trillion per day between June 2022 and the end of June this year to $1.5 trillion on Thursday. Money market trading firm Curvature Securities said in a research note this week that by the end of next year all of the money will likely be gone from reverse repo deals and the investment will return to where it was just over two years ago.
For some time, the Federal Reserve has returned significant amounts of money to the Treasury, and that money has been used to reduce federal deficits.
James Bullard, former head of the St. Louis Federal Reserve, said in an interview Wednesday that he was “concerned” about the central bank’s losses and that “it would be better not to do this.” He said it probably would have been better if the Fed had kept some of the trillions of dollars it gave the Treasury over the last decade to cover the kind of losses it is now suffering, but he pointed out that This is not the federal government’s system. The reserve has been formed. The Congress. .
If the Federal Reserve stops losing money, it will be years before it can remove the deferred assets from its books and begin returning cash to the Treasury. In 2022, the Federal Reserve repaid $76 billion, up from $109 billion in 2021.
In addition, these high incomes were associated with the very low tax rates at the time. It remains an open question whether the Fed can return to this scenario, although some at the central bank, particularly New York Fed President John Williams, are optimistic that it can happen.