Fed Is Losing Billions, Wiping Out Profits That Funded Spending

(Bloomberg) — Profits and losses aren’t usually thought of as central bankers’ considerations, but red ink is quickly rising at the Federal Reserve and many peers risk becoming more than just an accounting oddity.

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The bond market is experiencing its worst selloff in a generation, fueled by inflation and aggressive interest rate hikes by central banks. Falling bond prices, in turn, mean paper losses on the huge stocks that the Fed and others have amassed during bailout efforts in recent years.

Rate hikes also include central banks paying higher interest rates on reserves held by commercial banks. This has pushed the Fed into operating losses and created a hole that it may eventually require the Treasury Department to fill by selling debt. The UK Treasury is already preparing to cover losses at the Bank of England.

The UK move marks a sharp shift in countries including the US, where central banks are no longer significant contributors to government revenue. According to Amherst Pierpont Securities LLC, U.S. Treasuries will see a “shocking turnaround” from taking nearly $100 billion last year from the Fed to a potential annual loss of $80 billion by the end of the year.

Accounting losses threaten to criticize asset purchase programs to save markets and economies, most recently when Covid-19 shut down large parts of the global economy in 2020. Coupled with the current spike in inflation, that could fuel calls to curb it. the independence of monetary policymakers or limiting what steps they can take in the next crisis.

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“The problem with central bank losses is not the losses – they can always be recapitalized – but the possibility that central banks will face a political backlash,” said Jerome Haegeli, chief economist at Swiss Re, who previously worked at the Swiss central bank. .

The following figures show the extent of operating losses or market balance losses that are currently being realized:

  • Fed transfers to US Treasuries hit a negative $5.3 billion through Oct. 19, a sharp contrast to the positive numbers seen as recently as late August. A negative number equals an IOU that will be repaid through any future earnings.

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

  • Dutch central bank governor Klaas Knoth warned last month that he expects accumulated losses of around 9 billion euros ($8.8 billion) over the coming years.

  • The Swiss National Bank reported a loss of 95.2 billion francs ($95 billion) in the first six months of this year as the value of its currency holdings fell, the worst first-half showing since it was founded in 1907.

While for a developing country, a loss in the central bank can erode confidence and contribute to general capital outflows, such confidence problems are unlikely for a rich country.

As Seth Carpenter, Morgan Stanley’s chief global economist and a former US Treasury official, said: “The loss will not have a material impact on their ability to conduct monetary policy in the near term.”

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Asked last month about the Australian central bank’s negative equity position, RBA deputy governor Michelle Bullock said “we don’t believe we’re going to have any impact on our ability to operate at all.” After all, “we can create money. That’s what we did when we bought the bonds,” he noted.

But the consequences are still there. Central banks have already become political institutions after, by their own admission, they failed to predict inflation and act quickly against inflation over the past year or so. Vulnerability adds another magnet for criticism.

ECB influence

For the European Central Bank, the potential for higher losses after government bond purchases looms despite reservations from conservative officials that they have blurred the line between monetary and credit policy.

With inflation hovering at five times the ECB’s target, pressure is mounting to shed its bond holdings – a process called quantitative easing, which the ECB is now gearing up for even as the economic outlook darkens.

Economists at Goldman Sachs Group Inc. George Cole and Simon Freisenet said, “Although there are no clear economic limits to the central bank’s losses, they are likely to become more of a political limit for the ECB.” Especially in northern Europe, it “could contribute to the discussion of quantitative easing.”

President Christine Lagarde gave no indication that the ECB’s QT decision was motivated by potential losses. He told lawmakers in Brussels last month that profit-making is not part of central banks’ job, insisting that tackling inflation remains the “sole objective” of policymakers.

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BOJ, Fed

The Bank of Japan remains isolated for now, not raising interest rates and still holding a negative rate on some of the 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 historically opposed the practice of paying interest on excess bank reserves. Congress granted this authority back in 2008 to help the Fed control interest rates. With the Fed now in losses and Republicans likely to control at least one chamber of Congress in November’s midterm elections, the debate could reignite.

Changes in the Fed can be particularly significant. After paying up to $100 billion to the Treasury in 2021, it could lose more than $80 billion a year if policymakers raise rates by 75 basis points in November and 50 basis points in December, as markets anticipate. . Stephen Stanley, chief economist at Amherst Pierpont.

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

“It may be very interesting to hit the public radar, but a populist could spin the story in a way that doesn’t reflect well on the Fed,” Stanley wrote in a note to clients this month.

–Courtesy of Garfield Reynolds.

(Add Bank of Japan after subheading “BOJ, Fed”.)

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