Fed Is Losing Billions, Wiping Out Profits That Funded Spending

(Bloomberg) — Profits and losses aren’t usually considered a consideration for central banks, but the rapidly lining up of red ink at the Federal Reserve and many risk peers is becoming more than just an accounting oddity.

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The bond market is enduring its worst sell-off in a generation, triggered by high inflation and aggressive interest rate hikes by central banks. The bond price hikes, in turn, mean paper losses on the massive holdings that the Fed and others have accumulated during their rescue efforts in recent years.

Rate hikes also involve central banks paying more interest on the reserves that commercial banks bank with them. This tilts 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 a loss in the Bank of England.

Britain’s move highlights a dramatic shift in countries including the United States, where central banks no longer contribute significantly to government revenue. The US Treasury will see a “stunning swing,” 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 undercut asset purchase programs undertaken to save markets and economies, most recently when Covid-19 shut down large parts of the global economy in 2020. Coinciding with the current epidemic of inflation, this could push call to control. 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 policy backlash central banks are more 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 losses or mark-to-market balance sheet losses that have now materialized:

  • Fed remittances owed to the U.S. Treasury reached a negative $5.3 billion as of Oct. 19 — a sharp contrast to the positive figure seen as recently as late August. A negative number is an IOU that should be 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 $12.4 billion.

  • Dutch central bank governor Klaas Knot warned last month that he expects cumulative losses of 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 currency fell — the worst first-half performance since it was established in 1907.

While for a developed country, the loss of the central bank can undermine confidence and contribute to a general exodus of capital, this type of credibility challenge is unlikely for a rich nation.

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

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

But there can still be consequences. Central banks have already become politically charged institutions after, by their own admission, they failed to anticipate and act quickly against burgeoning inflation in the past year or more. Losing adds another magnet for criticism.

ECB Implications

For the European Central Bank, the potential for leveraged losses comes after years of government bond purchases made despite reservations from conservative officials who argued that they blur the line between monetary and fiscal policy.

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

“Although there are no clear economic constraints on the central bank running losses, there is the possibility that these become more of a political constraint on the ECB,” Goldman Sachs Group Inc. economists George Cole and Simon Freycenet said. Especially in northern Europe, it “can fuel the discussion of quantitative tightening.”

President Christine Lagarde gave no indication that the ECB’s decision on QT will be driven by the prospect of making losses. He told lawmakers in Brussels last month that generating profits is not part of the job of central banks, insisting that fighting inflation remains the “sole objective” of policymakers.

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BOJ, Fed

The Bank of Japan remains silent for now, not raising interest rates and still imposing a negative rate on a portion of bank 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 voiced opposition to its practice of paying interest on surplus bank reserves. Congress gave this authority in 2008 to help the Fed control interest rates. With the Fed now losing money, and Republicans potentially taking control of at least one chamber of Congress in the November midterm elections, the debate may resurface.

The Fed’s shift could 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 expected by the markets – estimated. Stephen Stanley, chief economist for Amherst Pierpont.

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

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

–With assistance from Garfield Reynolds.

(Add reference to Bank of Japan after ‘BOJ, Fed’ subtitle.)

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