Do the Fed’s bond losses actually matter?

Do the Fed’s bond losses actually matter?

Alexander Digby

Compliance Associate

Summary:  The Federal Reserve is reporting an operating loss for the first time in over a century, with projected net interest losses of $60 billion for 2023. While that may not be a cause for concern just yet, the risk of a coming political crisis cannot be ignored


‘There aren’t many straight lines in finance,’ was the quip of Harry Markopolos, the accountant that uncovered Bernie Madoff’s infamous Ponzi scandal as he noticed Madoff’s earnings only went one way -a straight line up at a 45-degree angle. Well, there’s another chart currently turning heads in the financial world at the moment. This straight line, however, is going down at a 90-degree angle. Worryingly, that chart is the graph of the Federal Reserve’s FY22 earnings. It’s about as close as you can get in finance to a pure cliff-edge.

Picture1

The Federal Reserve's recent operating losses have sparked concerns about the impact on the US economy. The Fed's earnings for FY22 are on track to decline steeply, with projections suggesting net interest losses of $60 billion for 2023 and $15 billion for the following year. This is the first time in over 100 years the Fed is reporting an operating loss, and the trend is worrying analysts. It isn’t just the Fed either, it is losses on the portfolios of the Bank of England, European Central Bank and Bank of Japan too.

The Bank of England has suggested that central bank losses only become a problem when they exceed the net present value of potential future earnings. In other words, as long as the central bank can continue to earn positive seigniorage by earning more on its assets than it pays on its liabilities, they can continue to manage the economy. The Fed is not yet close to the complete wipeout that would precede loss of control of monetary policy. However, the reversal of years of remittances from the Fed to the Treasury, along with persistently high inflation, will no doubt mean a grilling of Jerome Powell by the policymakers in the U.S. Capitol.

Politically, there will be a reluctance to authorise tens of billions in payments to the Fed to cover its operations, especially given that the Fed has previously sent close to $800 billion of Q.E. profits to the Treasury. This reversal of remittances is likely to be met with resistance from Congress, and the potential implications are that the Fed could become increasingly politicised. Just like the political brinkmanship over the U.S. statutory debt limit, the Fed too could find itself facing a dangerous political crisis. 

While the Fed can lose money in the short-term and still maintain a positive net present value of seigniorage earnings, this is not a viable solution in the long run. The Fed needs to find a way to return to profitability in the coming years to avoid long-term damage to the economy. As former Reserve Bank Australia Governor Glenn Stevens once said, negative central bank capital is "not a good look" and could damage confidence in the US currency.

While the Fed's operating losses will not immediately prevent it from managing the country’s monetary policy, they highlight the need for the Fed to take action to return to profitability in the coming years. The political implications of having to authorise payments to cover the Fed's operations will become a political football in the long-run, and the Fed needs to find a way to maintain positive earnings in the long run to avoid a damaging political crisis and loss of confidence in the US currency.

 

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992