The Federal Reserve (Fed) appears to have finally overcome a three-year series of unprecedented losses linked to how it implemented monetary policy in the wake of the Covid-19 pandemic.
In recent weeks, data released by the central bank show that since early November the Fed began making enough money again to very slowly begin covering an accounting mechanism it uses to capture its losses.
Since November 5, the size of the Fed’s so-called deferred assets has been reduced, from $243.8 billion to $243.2 billion on November 26. It’s a small change, but it’s also a clear change in a long-term trend.
Fed watchers don’t know how long it will take for the Fed to cover its deferred assets and return cash back to the Treasury, but they suspect the effort will be measured in years.
Bill Nelson, a former top Fed official who is now chief economist at the Bank Policy Institute lobbying group, said that by tracking the financial performance of the Fed’s regional banks, the Fed “appears on track for the combined profits of the 12 Reserve Banks to exceed $2 billion in the current quarter.”
The Fed’s deferred asset accumulates losses that must be covered before the Fed can return its profits to the Treasury, as required by law. The Fed funds its operations with the income it obtains from its bond holdings and the services it provides to the financial sector. The remainder is returned to the Treasury.
You may be interested in: Rate cut odds double after Fed official signal support
Fed says profits and losses do not affect monetary policy
For most of the Fed’s modern history, this setup made it a steady source of revenue for the rest of the government. But this changed during the pandemic, which ultimately caused the Fed to start losing money in September 2022.
To stabilize the financial system and provide additional economic stimulus, the Fed purchased Treasury and mortgage bonds to reduce long-term borrowing costs. This more than doubled the size of the Fed’s holdings, peaking at $9 trillion by summer 2022.
The challenge for the Fed emerged the same year its bond holdings peaked. Rising inflationary pressures forced the Fed to sharply raise interest rates in early 2022. This created a growing mismatch between the revenue the Fed was earning and what it had to pay banks to manage interest rates.
The rate cuts largely curbed the Fed’s losses, meaning it has been paying banks less to maintain the federal funds rate target range, which now sits between 3.75 and 4%, after hitting between 5.25 and 5.5% in 2023. More rate cuts are likely on the way for the Fed as officials worry about the state of the labor market.
“Taken together, it appears that the buildup of deferred assets stopped at the same time that interest on reserve balances (IORB) fell 25 basis points in October,” said Derek Tang, an analyst at LHMeyer. “Digging deeper, it appears that this means that negative carry has ended, as opposed to idiosyncratic gains from large foreign exchange seigniorage gains,” he added.
Matthew Luzzetti, chief U.S. economist at Deutsche Bank, said that “with market yields starting to move above the IORB, the Fed’s losses would be expected to stop and reverse.”
Fed officials have repeatedly stated that the central bank’s profits and losses do not affect its ability to manage monetary policy. However, some elected officials criticized its ability to pay interest, arguing that this money created by the central bank to keep short-term rates in the desired range constitutes, in reality, a subsidy to the financial system.
With information from Reuters
Subscribe to our YouTube channel and don’t miss our content
