The Fed’s Losses Could Take Years to Make Back

Charts of the Week — December 9, 2022

Central Banks By Gregory Blaha

The Fed's cumulative losses now total over $13 billion.

In an August 5 Charts of the week post, we walked through some of the math Judy Shelton used in asserting the Fed may soon find itself operating at a loss. In a mid-October post, we pointed out the Fed was actually operating at a loss. With losses quickly piling up, many clients have asked for an update.

As we pointed out back in August, the Fed receives income from the Treasuries and MBS in its SOMA portfolio. It pays out interest on the reserves (IOR) primary dealers have with the Fed and to money market funds who park funds at the Fed’s reverse repo facility (RRP).

The rate of the coupon payments the Fed receives on their SOMA portfolio will remain about the same while the interest they pay on the RRP and IOR will rise. In simpler terms, the Fed is funding fixed-rate assets against floating-rate liabilities.

At the time of the original post walking through Judy Shelton’s math, the Fed was paying between 2.30% and 2.40% to those two groups. Now they are paying 3.80% and 3.90% (blue and red lines). The market currently expects the upper bound of the funds rate to end the year at 4.50%, which would put the RRP and IOR rates at 4.30% and 4.40%, respectively.

 

 

In the week ending December 7, it is estimated the Fed’s cumulative losses totaled over $13 billion. The chart below shows how rare a loss of this magnitude has been over the past decade.

 

 

It should be noted that none of this changes the Fed’s ability to continue hiking rates. They will simply account for these losses by writing an IOU to the Treasury in the form of a ‘deferred asset’. In simple English, the Treasury will make these losses back whenever the Fed begins to turn a profit once again.
That being said, a July Fed study estimated this ‘deferred asset’ could be on the balance sheet through the end of 2025 in their baseline scenario (black line, right chart). Using a 70% confidence interval, these losses could remain on balance sheet through the end of 2028. In simple terms, the Treasury will likely have to accept an IOU from the Fed for losses for the next few years, and possibly much longer.

 

 

Given rates began marching higher once again after this report’s release, these estimates may be on the conservative side. It will likely take many years before the Treasury recovers these losses.