Projections show Fed could permanently hang on to more U.S. bonds

FILE PHOTO: A police officer keeps watch in front of the U.S. Federal Reserve building in Washington, DC, U.S. on October 12, 2016. REUTERS/Kevin Lamarque/File Photo

NEW YORK (Reuters) - The Federal Reserve’s $4.4-trillion in bond holdings may not shrink as much as previously assumed, and could settle around $3 trillion by the beginning of 2021, the New York Fed said on Tuesday in annual projections.

Last year’s median estimate saw the portfolio shrink to around $2.8 trillion by the end of 2021, suggesting a combination of interest-rate hikes, market fluctuations and shifting consensus among policymakers could permanently leave the Fed with a larger portfolio of assets.

The projections, based on published Fed and Wall Street predictions, show a range of scenarios in which the U.S. central bank continues logging profits from the assets and turning over tens of billions of dollars to the U.S. Treasury. Those scenarios included the portfolio dropping to between $2.5 trillion and $3.3 trillion, between the years 2020 to 2022.

The Fed had only about $900 billion in assets before the 2007-2009 financial crisis and recession. But in response it snapped up some $3.5 trillion in Treasury and mortgage bonds to encourage U.S. investment, hiring and economic growth.

In the face of a strong economy and in an effort to keep its powder dry for the next downturn, the Fed started in October to gradually shed bonds as they matured. Policymakers have not said how far they plan to wind down the portfolio, a process that could also help insulate the Fed from future losses and potential political criticism.

The Fed derives profit from the holdings and sends it to the government in a quiet windfall for taxpayers. In January it said it would send $80.2 billion in such remittances, down from $91.5 billion in 2016, in part due to a rise in the interest it pays to banks on excess reserves. The interest paid to banks last year was $13.8 billion, up from $12 billion in 2016.

The New York Fed, which manages the portfolio, projected that net annual income would fall to a trough of $52 billion in 2020, when its portfolio would consist of roughly 60 percent Treasuries.

Last year it shed about $28 billion in assets, and this year expects to redeem about $230 billion in Treasuries and $162 billion in agency debt and mortgage bonds. The New York Fed stressed the assumptions would be influenced by several things including future policy decisions and economic and market conditions.

Reporting by Jonathan Spicer; Editing by Chizu Nomiyama