Not that the losses matter to the Fed, but they matter to the Budget Deficit.
By Wolf Richter for WOLF STREET.
Since September 2022, the Fed has consistently booked operating losses, as the interest it pays banks on their “reserves” and the interest it pays money market funds and other counterparties on their overnight reverse repurchase agreements (ON RRPs) have overpowered the interest income from its vast but shrinking portfolio of Treasury securities and MBS that it purchased when yields were much lower than today.
The cumulative loss since September 2022 reached $100.1 billion, as per the Fed’s balance sheet released last Thursday. The losses have stabilized in a wave-like pattern since late February, despite three additional rate hikes since then. And more recently, they have started to diminish. If the Fed keeps rates unchanged this week, those losses will decline further – more in a moment.
The chart shows the weekly losses (green) and the four-week moving average of the weekly losses (red). In August and September so far, the weekly losses have averaged a little under $2.5 billion per week.
The Fed’s losses increased with the rate hikes, as it had to pay higher interest rates on reserves and RRPs. Since the rate hike in July, the Fed has been paying 5.4% to the banks and 5.3% to the RRP counterparties.
But the balances of reserves and RRPs declined as a result of QT – we discussed the Fed’s liabilities, including reserves and RRPs on Saturday – and there are now over $1 trillion less in combined balances outstanding that the Fed needs to pay interest on, compared to the peak in December 2021.
So the declining combined balances of reserves and RRPs kept the interest the Fed pays in dollar terms roughly level for the past five months in a wave-like pattern. In August and September so far, the weekly losses have averaged a little less than $2.5 billion per week.
As reserves and RRPs continue to fall, there will be less to pay interest on. If the rates remain around 5.5%, total losses will begin to diminish visibly over the next few months as QT continues to drain the combined balances of reserves and RRPs.
RRPs may eventually return to zero as QT continues. They’ve already plunged by 45% to $1.45 trillion as of today’s New York Fed data. So interest payments to RRP counterparties are now plunging as well:
Reserves might fall below $2 trillion as QT continues. They’ve already fallen by 30% from the peak, despite the recent uptick, to $3.34 trillion.
Losses don’t matter to the Fed.
The Fed creates and destroys money as a matter of routine. Because it can create money, it can never run out of money. So its losses don’t mean anything in particular for the Fed. It just accounts for its operating losses in its liability account, “Earnings Remittances due to the US Treasury” – money that it owes the US Treasury.
This liability account, “Earnings Remittances due to the US Treasury,” where the Fed tracks its operating losses, has a negative value of $100.1 billion. Funniest-looking chart ever:
Note that these operating losses (expenses exceed interest income) are different than the unrealized capital losses on its bond holdings, which don’t matter either for the same reason, plus another reason: the Fed will not sell its Treasury securities, but hold them to maturity at which point it will receive face value for them, and will not incur capital losses.
There was some discussion by some Fed governors that it might eventually think about selling some MBS to speed up the process of QT, and it would then realize capital losses on those MBS that it sold, but those capital losses won’t matter either for the Fed.
It already sold all its corporate bonds and bond ETFs that it had purchased in 2020 and made a profit of $512 million on those sales.
But the Fed’s losses matter to the US budget deficit.
The Fed remits nearly 100% of its income to the US Treasury Department, being in sort of a 100% income tax bracket. In 2022, it still remitted $76 billion to the Treasury through August. But then it started making losses and there was no more income to remit.
Since 2001, the Fed has remitted $1.36 trillion in income to the Treasury. That gravy train has now derailed. Those remittances will be zero for years to come:
Now the Fed has losses and won’t remit anything. Even when it starts making money again years from now, it won’t remit anything until all the cumulative losses – already $100 billion and growing – have been earned back. This will take many years. Over this period of losses, and then of income to earn back those losses, the US deficit will be worse by the amount of the missing remittances.
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