Fed says surging interest costs cut what it handed back to Treasury in 2022

U.S. dollar banknotes are displayed in this illustration taken, February 14, 2022. REUTERS/Dado Ruvic/Illustration

NEW YORK, Jan 13 (Reuters) - The Federal Reserve said Friday that it handed back substantially less money to the Treasury last year than it did the year before, amid rising interest expenses tied to its work to lower inflation.

The Fed said in astatement its net income last year stood at a preliminary $58.4 billion, compared to 2021’s $107.9 billion. The Fed noted that in September of last year it began recording what’s called a deferred asset that tallies up the loss, which stood at $18.8 billion at the end of the year.

The Fed said it transferred $76 billion in weekly earnings to the Treasury. The deferred asset accounting measure records the loss and will be covered in the future when the Fed returns to profitability.

By law the Fed hands back any excess earnings to the Treasury after it covers its expenses. The Fed earns money from interest on bonds it owns and from services it provides to the financial sector.

The Fed reiterated in its statement that the net negative income situation it is now operating under does not impair its ability to pursue its monetary policy objectives.

The turn to technical losses for the Fed is driven by the central bank’s aggressive rate rise campaign last year, which saw it raise its rate target from near zero levels to between 4.25% to 4.5% by year’s end. That sharply increased the amount of interest expenses faced by the central bank last year.

In 2022, the Fed says that interest expenses surged to $102.4 billion last year, from 2021’s $5.7 billion.

The Fed seeks to influence the course of economy's momentum primarily by adjusting a market-based rate called the federal funds rate. The Fed keeps that rate in the desired range by adjusting two other rates it pays to a mix of bank and investment firms. Those two rates have risen along with the fed funds rate, which is why the Fed's interest costs increased so much last year.

LOSES EXPECTED TO MOUNT AS YEAR MOVES FORWARD

As of the Fed's most recent data, its de facto loss has now risen to $22.6 billion. Analysts believe that number will grow much larger over the course of the year, and they are unsure when the Fed will return to overall profitability.

"Considering our forecast for Treasury yields, the fed funds rate, and the broader economy, losses on the Fed's balance sheet will likely not exceed $1 trillion even with additional rate hikes," economists at Capital Economics said in a research note from early January, noting "each rate hike increases the central bank's interest expense and will add to their losses."

Derek Tang, an economist at analyst firm LH Meyer, said he expects to see the Fed operating in the red for a while and that if it does what it has penciled in and hikes to a 5.1% funds rate this year, it will likely lose $100 billion for each year it holds at that level.

Tang noted that as Fed profits have been used to reduce deficits in years past, the shortfall this year will mean either higher government borrowing or some sort of tax increases.

While the operating losses now seen by the Fed won't affect its operations and mission to lower inflation, the amount of money it is now handing over to banks, money funds and others could become a political challenge.

Some Fed watchers believe the central bank could face pressure from elected leaders, especially if the economy runs into trouble due to the Fed rate hikes. There are widespread fears central bank rate increases, which will continue into this year, will drive up unemployment and even send the overall economy into contraction.

If that happened, the Fed could faces questions as to why it is handing over substantial sums of money to financial firms at a time when many Americans might be facing pain due to the stance of monetary policy.

Some analysts have noted that if Congress does take aim at the Fed over losses it would be wrong to do so, because Congress set the rules in the first place. The Fed has been handing back tens of billions to the government for years instead of building up a capital buffer to deal with potential losses, these Fed watchers have noted.

Reporting by Michael S. Derby; Editing by Chizu Nomiyama

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