This article first appeared on Bloomberg on 10th October. By Tracy Alloway
The Federal Reserve is posting its first operating loss in years as interest rates soar and demand for US bonds craters. Fed data show the central bank reporting earnings remittances due to the US Treasury of negative $2.9 billion as of Oct. 5.
It’s a stark, though not unexpected, turn of events for a central bank that made billions in extra interest income from its expanding balance sheet in the years since the financial crisis. Of course, the Fed isn’t a “normal” investor. It cannot go bankrupt and any operational losses stemming from its vast portfolio of bonds will simply mean it remits less money to the US Treasury.
But it does highlight the dramatic shift in the economic environment and could make for uncomfortable optics at a time when the Fed is already under pressure to bring down inflation. The central bank has ramped up its fight against higher prices, paying added interest on bank reserves and through programs like the reverse repurchase agreement facility, better known as the RRP, as it attempts to dampen demand.
“The Fed's interest expense — the interest it pays banks and RRP counterparties — increases with each rate hike,” says Joseph Wang, a former trader on the central bank’s open markets desk and the founder of the Fed Guy blog. “The 75 basis point September rate hike pushed the Fed into an operating loss. With expectations for a ‘higher for longer’ Fed, the operating loss is likely to significantly increase in the coming months.”
As Wang explains, the move to an operating loss is notable because it so rarely happens. In the years since the global financial crisis, the US central bank earned more than $1 trillion in interest income that it remitted to the US Treasury.
And while losses are likely to be uncomfortable for Fed policymakers who will have to answer awkward questions about it, it’s not expected to have a major effect on monetary policy.
“This isn't something to be concerned about because it doesn't have a meaningful impact on monetary policy and is likely temporary,” Wang adds. “The Fed cannot go broke, and the operating loss will go away when the Fed cuts rates during the next downturn. The optics of a money-losing Fed aren't good, though.”
My analysis
For context here is an article about why the Fed pays interest on excess funds. The Fed uses authority granted by Congress in 2008 to pay interest on the reserves that banks hold with it. Total payments to banks last year (2015) were about $7 billion. Why is the Fed paying such sums to banks? Are they “giveaways” to the financial sector, as some have implied?
Since December 2021, the Fed has been in a rate hike cycle.
The Fed also increased the amount of interest it would pay on excess reserves and cash, in exchange for collateral. Janet Yellen had to reduce the Treasury General Account which pushed reserves onto banks' balance sheets. This meant that they needed to raise capital to keep within the Supplementary Leverage Ratio. The Fed offered to pay a higher % of interest on short-term loans of cash to the Fed, in exchange for HQ collateral.
The US debt pile is still growing, though the issuance of debt has been reduced this year. We're just waiting for the November reading of Interest Paid to complete the interest on securities for 2022.
The above graph is giving no indication that interest rates are about to collapse. Therefore we wait to see what the Fed and Congress come up with, to keep this mad scheme of paying interest on debt back to the government carrying on.