Federal Reserve ends three-year loss streak from Covid-era monetary policy
The Fed’s deferred asset reflects losses that must be covered before it can resume payments to Treasury
[WASHINGTON] The Federal Reserve appears to have finally turned the corner on a three-year-long string of unprecedented loss-making tied to how it has implemented monetary policy in the wake of the Covid-19 pandemic.
Over recent weeks, data released by the central bank shows that since the start of November the Fed has started to make enough money again to very slowly start covering an accounting mechanism it uses to capture its losses.
Since Nov 5, the size of the Fed’s so-called deferred asset has gotten smaller, moving from US$243.8 billion to US$243.2 billion on Nov 26. It is a small change, but it is also a clear shift in a long-term trend.
Fed watchers do not know how long it will take for the Fed to cover its deferred asset and again return cash to the Treasury, but they suspect that effort will be measured in years.
Bill Nelson, a former top Fed staffer who is now chief economist for lobbying group the Bank Policy Institute, said that by tracking the financial performance of the regional Fed banks, the Fed “appears to be on track for the combined profits of the 12 Reserve Banks to be over US$2 billion in the current quarter.”
The Fed’s deferred asset tallies up losses that must be covered before the Fed can again return its profits to the Treasury, as it is required to do by law. The Fed funds its operations through income it earns from its bond holdings and from services it provides to the financial sector.
Whatever is left over is then handed back to the Treasury. That setup has for most of the Fed’s modern history made it a steady source of income for the rest of the government. But that changed during the pandemic, which ultimately led the Fed to begin to lose money in September 2022.
Pandemic bond-buying spree
To help stabilise the financial system and provide additional economic stimulus, the Fed bought Treasury and mortgage bonds to depress longer-term borrowing costs. That more than doubled the size of Fed holdings to a peak of US$9 trillion by the summer of 2022.
The challenge for the Fed emerged in the same year its bond holdings topped out. Surging inflation pressures caused the Fed to sharply raise rates starting in early 2022. That generated a rising mismatch in the income the Fed was making relative to what it needed to pay out to banks to manage interest rates.
Rate cuts have largely halted the Fed’s loss-making, which means it has been paying out less to banks to maintain the federal funds target rate range, which now stands at between 3.75 per cent and 4 per cent, after hitting between 5.25 to 5.5 per cent in 2023. More rate cuts likely lie ahead for the Fed as officials worry about the state of the job market.
“In aggregate, it does look like the bleeding (accumulation of deferred asset) stopped at the same time (interest on reserve balances, or IORB) was cut 25 basis points in October,” said Derek Tang, an analyst at LHMeyer. “Digging deeper, it does look like it means negative carry has ended, as opposed to idiosyncratic profits from large seigniorage profits from currency,” he added.
Matthew Luzzetti, chief US economist at Deutsche Bank, said “with market yields beginning to move above IORB you would expect that the Fed losses stop and turn around.”
Fed officials have said repeatedly that profits and losses at the central bank have no bearing on its ability to conduct monetary policy. But some elected officials have taken aim at its interest-paying powers, arguing that this money created by the central bank to keep short-term rates in the desired range is effectively a subsidy to the financial system. REUTERS
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