Fed Is Losing Billions, Wiping Out Profits That Funded Spending

(Bloomberg) — Profits and losses are not normally considered a consideration for central banks, but rapidly increasing red ink at the Federal Reserve and many of its peers risks becoming more than just an accounting oddity.

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The bond market is suffering the worst sell-off in a generation, caused by high inflation and the aggressive increases in interest rates that central banks are implementing. Falling bond prices, in turn, mean paper losses on the large holdings that the Fed and others have accumulated during their rescue efforts in recent years.

Rate increases also involve central banks paying more interest on the reserves that commercial banks park with. This has led the Fed into operating losses, creating a hole that may ultimately require the Treasury Department to fill through debt sales. The UK Treasury is already preparing to make up for losses at the Bank of England.

Britain’s move underscores a dramatic shift in countries including the United States, where central banks are no longer significant contributors to government revenue. The US Treasury will see a “stunning swing”, going from receiving about $100 billion last year from the Fed to a potential annual loss rate of $80 billion by the end of the year , according to Amherst Pierpont Securities LLC.

The accounting losses threaten to fuel criticism of the asset purchase programs undertaken to rescue markets and economies, most recently when Covid-19 shut down large parts of the global economy in 2020. Coinciding with the current burst of inflation, this could fuel calls to curb the independence of monetary policy makers, or limit what steps they can take in the next crisis.

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“The problem with central bank losses is not the losses per se – they can always be recapitalized – but the political backlash central banks are increasingly likely to face,” said Jerome Haegeli, chief economist at Swiss Re, who previously worked in Switzerland. central bank.

The following figures show the scope of the operating loss or balance sheet loss according to the market value that is now materializing:

  • Fed remittances owed to US Treasuries hit a negative $5.3 billion as of October 19 — a stark contrast to the positive numbers seen as recently as late August. A negative number amounts to an IOU that is repaid through any future income.

  • The Reserve Bank of Australia posted an accounting loss of A$36.7 billion ($23 billion) for the 12 months to June, leaving it with a negative equity position of A$12.4 billion.

  • Dutch central bank Governor Klaas Knot warned last month that he expects a cumulative loss of around 9 billion euros ($8.8 billion) for the coming years.

  • The Swiss National Bank reported a loss of 95.2 billion francs ($95 billion) for the first six months of the year as the value of its foreign exchange holdings fell – the worst first-half performance since established in 1907.

While for a developing country, losses in the central bank can undermine confidence and contribute to a general exodus of capital, that kind of credibility challenge is unlikely for a rich nation.

As Seth Carpenter, chief global economist for Morgan Stanley and a former US Treasury official, said: “The loss does not have a material effect on their ability to conduct monetary policy in the short term.”

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RBA Deputy Governor Michele Bullock said in response to a question last month about the Australian central bank’s negative equity position that “we do not believe we are affected at all in our ability to operate.” After all, “we can create money. That’s what we did when we bought the bonds,” she noted.

But there can still be consequences. Central banks had already become politically charged institutions after, by their own admission, failing to anticipate and act quickly against rising inflation over the past year or so. Suffering a loss adds another magnet for criticism.

Implications of the ECB

For the European Central Bank, the potential to increase losses comes after years of government bond purchases made despite the reservations of conservative officials who argue that it has blurred the lines between monetary and fiscal policy. fiscal.

With inflation running at five times the ECB’s target, pressure is mounting to dispose of bond holdings – a process called quantitative tightening that the ECB is currently preparing for even as the economic outlook darkens.

“Although there are no clear economic constraints to the central bank’s losses, there is the possibility that they will become more of a political constraint on the ECB,” Goldman Sachs Group Inc. economists said. George Cole and Simon Freycenet. Particularly in Northern Europe, “it could trigger the discussion about quantitative tightening.”

President Christine Lagarde gave no indication that the ECB’s decision on QT will be driven by the prospect of incurring losses. She told lawmakers in Brussels last month that generating profits is not part of the task of central banks, insisting that fighting inflation remains “the sole purpose of those who policy makers”.

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BOJ, Fed

The Bank of Japan remains out for now, has not raised interest rates and still imposes a negative rate on a portion of banks’ reserves. But things could change when Governor Haruhiko Kuroda steps down in April, and his successor faces historically high inflation.

As for the Fed, Republicans have in the past expressed opposition to its practice of paying interest on excess bank reserves. Congress gave that authority back in 2008 to help the Fed control interest rates. With the Fed now suffering losses, and Republicans potentially taking control of at least one chamber of Congress in November’s midterm elections, the debate could resume.

The Fed’s turnaround may be particularly notable. After paying as much as $100 billion to the Treasury in 2021, it could face losses of more than $80 billion on an annual basis if policymakers raise rates by 75 basis points in November and 50 basis points in ‘December — as the markets anticipate — estimates. Stephen Stanley, chief economist for Amherst Pierpont.

Without the income from the Fed, the Treasury then needs to sell more debt to the public to finance government spending.

“This may be too arcane to hit the public’s radar, but a populist can spin the story in a way that does not reflect well on the Fed,” Stanley wrote in a note to clients this month.

–With assistance from Garfield Reynolds.

(Adds a reference to the Bank of Japan after the subheading ‘BOJ, Fed’.)

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