Do the Fed’s bond losses actually matter?

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.