(Bloomberg) — Profits and losses aren’t usually considered a consideration for central banks, but the growing amount of red ink at the Federal Reserve and many peers risks becoming more than an accounting oddity.
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The bond market is suffering its worst sell-off in a generation, caused by high inflation and aggressive interest rate hikes being implemented by central banks. Falling bond prices, in turn, mean paper losses on the massive holdings the Fed and others have accumulated during their rescue efforts in recent years.
Rate hikes also mean that central banks pay more interest on the reserves that commercial banks park with them. That has driven the Fed into operating losses, creating a hole that may ultimately require the Treasury Department to fill through debt sales. The UK Treasury is already preparing to offset a loss at the Bank of England.
Britain’s move highlights a dramatic change in countries like the US, where central banks no longer contribute significantly to government revenue. The US Treasury will experience a “striking turnaround,” going from receiving about $100bn last year from the Federal Reserve to a potential annual loss rate of $80bn by the end of the year, according to Amherst. Pierpont Securities LLC.
Accounting losses threaten to fuel criticism of asset purchase programs undertaken to rescue markets and economies, most recently when Covid-19 shut down large swaths of the global economy in 2020. Coinciding with the current bout of inflation, that it could generate calls to control the independence of those responsible for monetary policy, or limit the steps they can take in the next crisis.
“The problem with central bank losses is not the losses themselves – they can always be recapitalized – but the backlash that central banks are increasingly likely to face,” said Jerome Haegeli, chief economist at Swiss Re, who previously worked at the Bank of Switzerland. central bank
The following figures illustrate the extent of operating losses or market-adjusted balance sheet losses that are now materializing:
Fed remittances owed to the US Treasury reached a negative value of $5.3 billion as of October 1. On January 19, a stark contrast to the positive figures seen recently, at the end of August. A negative number equates to a promissory note that would be repaid through any future income.
The Reserve Bank of Australia posted an accounting loss of A$36.7bn ($23bn) for the 12 months to June, leaving it with a negative capital position of A$12.4bn.
Dutch central bank governor Klaas Knot warned last month that he expects cumulative losses of some 9 billion euros ($8.8 billion) over the next few years.
The Swiss National Bank reported a loss of 95.2 billion francs ($95 billion) for the first six months of the year as the value of its foreign exchange holdings fell, the worst first-half performance since it was established in 1907.
While for a developing country, losses at the central bank can undermine confidence and contribute to a general exodus of capital, that kind of credibility challenge is not likely for a wealthy nation.
As Seth Carpenter, chief global economist at Morgan Stanley and a former US Treasury official, put it: “The losses do not have a material effect on their ability to conduct monetary policy in the short term.”
RBA Deputy Governor Michele Bullock said in response to a question last month about the Australian central bank’s negative capital position that “we don’t think it affects our ability to operate at all.” After all, “we can create money. That’s what we did when we bought the bonds,” she noted.
But there may still be consequences. Central banks had already become politically charged institutions after, by their own admission, failing to anticipate and act quickly against budding inflation for the past year or more. Incurring losses adds another magnet for criticism.
For the European Central Bank, the potential for mounting losses comes after years of government bond purchases made despite reservations from conservative officials who argue they blur the lines between monetary and fiscal policy.
With inflation five times higher than the ECB’s target, pressure is mounting to unload bond holdings, a process called quantitative tightening that the ECB is preparing for even as the economic outlook darkens.
“Although there are no clear economic constraints on the central bank taking losses, there is a possibility that they will become a political constraint on the ECB,” Goldman Sachs Group Inc. economists George Cole and Simon Freycenet said. Particularly in Northern Europe, “it may fuel the discussion about quantitative tightening.”
President Christine Lagarde has given no indication that the ECB’s decision on QT is driven by the prospect of incurring losses. She told lawmakers in Brussels last month that generating profits is not part of central banks’ job, insisting that fighting inflation remains the “sole purpose” of policymakers.
BOJ, Federal Reserve
The Bank of Japan is standing aside for now, has not raised interest rates and continues to impose a negative rate on a portion of banks’ reserves. But things could change when Governor Haruhiko Kuroda resigns in April and his successor faces historically high inflation.
As for the Fed, Republicans have in the past voiced opposition to its practice of paying interest on excess bank reserves. Congress gave that authority in 2008 to help the Fed control interest rates. Now that the Federal Reserve is making losses and Republicans are able to take control of at least one house of Congress in November’s midterm elections, the debate may resurface.
The Fed’s change of course could be particularly notable. After paying up to $100 billion to the Treasury in 2021, it could face losses of more than $80 billion annually if authorities raise rates by 75 basis points in November and 50 basis points in December, as markets anticipate estimates. Stephen Stanley, Chief Economist at Amherst Pierpont.
Without Federal Reserve revenue, the Treasury needs to sell more debt to the public to finance government spending.
“This may be too arcane to hit the public’s radar, but a populist could spin the story in a way that doesn’t reflect well on the Fed,” Stanley wrote in a note to clients this month.
–With the assistance of Garfield Reynolds.
(Adds a reference to the Bank of Japan after the subheading ‘BOJ, Fed’).
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