Federal Reserve losses have surpassed $100 billion, according to data released by the central bank. These losses are expected to increase further before stabilizing. The Fed is currently paying more in interest costs than it earns from bonds and financial services. Some experts believe that the losses, which began a year ago, could potentially double before improving. William English from Yale University predicts a peak loss of around $200 billion by 2025, while Derek Tang of LH Meyer forecasts a loss between $150 billion and $200 billion by next year.
The Fed records its losses as a deferred asset, which represents the amount it will eventually have to cover in the future before returning profits to the Treasury. While it is uncommon for the Fed to lose money, the central bank has emphasized that this situation does not hinder its ability to conduct monetary policy and achieve its goals.
The Fed’s losses are not surprising given its aggressive campaign to raise interest rates. The benchmark overnight interest rate has increased from near-zero levels in March 2022 to the current range of 5.25%-5.50%. With inflation pressures easing, it is widely expected that the Fed has completed or is close to completing its rate hikes.
However, the losses will continue to accumulate due to the current level of short-term rates. The losses will eventually subside as the Fed continues to shrink its balance sheet, which complements its rate hikes. Over the past year, the Fed has sold approximately $1 trillion in Treasury and mortgage bonds. Fed officials have indicated that there is more to be done in this regard, and financial markets anticipate a halt in the second or third quarter of 2024.
The liquidity targeted by the Fed primarily exists in the form of bank reserves and inflows to the central bank’s reverse repo facility. As the Fed reduces liquidity, it will cost less to tie up the remaining funds, even if the policy rate remains unchanged. The pace of losses will decrease as reserves and reverse repos decline, and new purchases of securities earn higher rates. However, there are numerous factors and uncertainties at play.
Bank reserves have declined by approximately $1 trillion from their peak at the end of 2021, while the daily outstanding levels of reverse repos have fallen from over $2 trillion to $1.5 trillion. It is possible that all the money will be out of reverse repos by the end of next year, returning the facility to its position two years ago.
For a long time, the Fed has returned significant amounts of money to the Treasury, which has helped reduce government deficits. James Bullard, the former head of the St. Louis Fed, expressed concern about the central bank’s losses and suggested that it would have been better for the Fed to retain some of the $1 trillion it has given to the Treasury over the past decade. However, the current system established by Congress does not allow for this.
Once the Fed stops losing money, it will take several years before it can remove the deferred asset from its books and begin returning cash to the Treasury. In 2022, the Fed returned $76 billion, following $109 billion in 2021. It remains uncertain whether the Fed will be able to return to the low-rate environment of the past, although some officials, such as New York Fed President John Williams, are optimistic about the possibility.
In conclusion, the Federal Reserve has experienced significant losses, which are expected to continue growing. However, the Fed’s ongoing efforts to shrink its balance sheet and reduce liquidity will eventually lead to a decrease in losses. It will take time for the Fed to recover and return cash to the Treasury.
