By Michael S. Derby
Dec 3 (Reuters) – The Federal Reserve appears to have finally turned around a three-year string of unprecedented losses linked to the way it has implemented monetary policy in the wake of the COVID-19 pandemic.
In recent weeks, data released by the central bank shows that since early November the Federal Reserve has started making enough money again to very slowly begin covering an accounting mechanism it uses to capture its losses.
Since November 5, the size of the Federal Reserve’s so-called deferred assets has been reduced, from $243.8 billion to $243.2 billion on November 26. It’s “a small change, but it’s also a clear change in a long-term trend.”
Fed watchers don’t know how long it will take for the Fed to cover its deferred asset and return cash to the Treasury again, but they suspect the effort will be measured in years.
Bill Nelson, a former top Fed official and now chief economist at the Bank Policy Institute lobbying group, said that by tracking the financial performance of the Fed’s regional banks, the Fed “appears to be on track for the combined profits of the 12 reserve banks to exceed $2 billion in the current quarter.”
The Fed’s deferred asset adds up to losses that must be covered before the Fed can return its profits to the Treasury, as required by law. The Federal Reserve funds its operations through the income it earns from its bond holdings and the services it provides to the financial sector. What is left over is returned to the Treasury.
That setup has made it for most of the Federal Reserve’s modern history a steady source of revenue for the rest of the government. But that changed during the pandemic, which ultimately led the Federal Reserve to start losing money in September 2022.
To help stabilize the financial system and provide additional economic stimulus, the Federal Reserve purchased Treasury bonds and mortgage bonds to reduce longer-term borrowing costs. That more than doubled the size of the Federal Reserve’s holdings to a peak of $9 trillion by summer 2022.
The challenge for the Federal Reserve emerged the same year its bond holdings peaked. Rising inflation pressures caused the Fed to sharply raise rates starting in early 2022. That led to a growing mismatch in the revenue the Fed was earning relative to what it needed to pay banks to manage interest rates.
The rate cuts have largely halted the Fed’s losses, meaning it has been paying banks less to maintain the target federal funds rate range, which now sits between 3.75% and 4%, after reaching between 5.25% and 5.5% in 2023. The Fed is likely to have more rate cuts ahead as officials worry about the state of the labor market.