While 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 tapering off.
William English, a former top central bank official now at Yale University, said he expects a “maximum” loss of about $200 billion by 2025. Derek Tang of forecasting firm LH Meyer. He said the loss is likely to be between $150 billion and $200 billion next year.
The Fed recognizes its losses in what it calls a deferred asset, an accounting measure that counts what it will eventually have to cover in the future before it can return to its normal practice of returning its profits to the Treasury.
The loss of money is a very unusual situation for the entity led by Jerome Powell.
But at the same time, the central bank has warned many times that the situation does not in any way affect its ability to conduct monetary policy and achieve its objectives.
That the Federal Reserve was losing money has not been a surprise given its aggressive campaign of interest rate hikes, which has taken the benchmark overnight rate from near zero in March 2022 to its current range of 5.25%. -5.50%.
As inflationary pressures ease, the Federal Reserve is widely expected to have ended its rate hikes, or be close to doing so.
Liquidity destruction
However, it does not mean that losses will stop increasing, as the current level of short-term rates will raise negative net income for quite some time. Losses will eventually stop primarily due to the Fed’s ongoing process of reducing its balance sheet, which complements its rate hikes.
The Federal Reserve aggressively bought bonds during the coronavirus pandemic and the immediate aftermath, dumping about $1 trillion in Treasury and mortgage bonds in just over the last year.
Federal Reserve officials have suggested there is still a gap on this front, and so the central bank will have to spend less on interest because it is removing liquidity from the financial system. Financial markets anticipate a slowdown in the second or third quarter of 2024.
The liquidity targeted by the Fed exists primarily in the form of bank reserves and inflows to the central bank’s reverse repurchase facility. Through these tools, the Fed pays banks, money managers and others to hold cash on its books, so that if liquidity dwindles, it costs the central bank less to tie up what’s left, even if its rate monetary policy does not change.
“The pace of losses will slow even if interest rates remain high, because reserves and (repos) are declining as securities are depleted, and new securities purchases are facing higher rates,” he said. English.
Monetary politics
For some time, the Fed has returned substantial amounts of money to the Treasury and this money has been used to reduce government deficits.
James Bullard, former head of the St. Louis Federal Reserve, said in an interview Wednesday that he is “concerned” about the central bank’s losses.
Bullard said it probably would have been better for the Fed to have kept some of the trillion dollars it has received from the Treasury over the last decade to cover the kind of losses it is now experiencing, but he noted that is not the system that Congress has established. .
When the Federal Reserve stops losing money, it will be years before it can take the deferred asset off its books and start returning cash to the Treasury. In 2022, the Fed returned $76 billion, after returning $109 billion in 2021.