Fed’s net income turned negative in September, but it was no surprise

By Michael S. Derby

NEW YORK (Reuters) – The Federal Reserve’s net income turned negative in September, minutes from its most recent policy meeting showed, although the largely technical development – previously flagged by its staff – will not affect the U.S. central bank’s ability to conduct monetary policy and does not threaten its financial position.

At the Sept. 20-21 meeting, a top New York Fed staffer said that “as expected, Federal Reserve net income turned negative in September.” The minutes, which were released on Wednesday, also noted that central bank staff expect the Fed will face negative income for some time. The looming turn to technical losses had been noted in the minutes for the Fed’s July policy meeting.

The U.S. central bank earns income from bonds it owns and from services it provides to the financial sector. After covering operational expenses it hands over any extra earnings to the Treasury.

In recent years the money handed back to the Treasury was substantial. The Fed transferred back $109 billion for 2021, the central bank said in March. That was well over the $86.9 billion in so-called remittances handed back in 2020.

The Fed’s bottom line is being pressured by the tools it uses to set monetary policy. The central bank deploys two rates to manage the federal funds rate, its chief lever to influence the path of the economy.

The federal funds rate now stands in the 3.00%-3.25% target range, and has risen rapidly from the near-zero level in March. To manage the funds rate, the Fed uses something called the reverse repo rate to set a low end – that rate is now at 3.05%, and another tool, the rate on reserve balances, to define the high end, now at 3.15%.

Both rates pay financial firms to park cash on the Fed’s books.

Some analysts had estimated that when the funds rate was somewhere in the 3% to 4% range, the money the Fed would need to pay out to maintain the reverse repo and reserve balances rate would tip it into a negative income space.

POLITICAL RISK

Fed officials have repeatedly stressed that central bank negative income is not like a conventional bank losing money. The Fed addresses negative income via what’s called a deferred asset, which is an accounting measure that the central bank would then seek to cover when it begins turning a profit again. As of the Fed’s most recent data, the size of this deferred asset now stands at $2.9 billion.

The minutes released on Wednesday said the deferred asset should rise over time, although no number was given. The minutes said “the staff expected that the size of the associated deferred asset would increase over time until net income turned positive, likely in a few years.”

One factor that will drive the deferred asset higher is the fact that the Fed is far from done raising rates, which means it will face even higher interest costs over time. The Fed has penciled in more rate increases while it seeks to lower inflation, which by the central bank’s preferred measure is running at more than three times its 2% target, and is eyeing a funds rate of around 4.6% next year.

Having net negative income “doesn’t impede the monetary policy that we’re doing, but I do think it poses a communications problem,” Cleveland Fed President Loretta Mester told reporters on Tuesday.

Fed watchers have said the biggest risk to the central bank from the negative income situation is political. Profits handed to the Treasury have been seen as a source of deficit reduction, for one thing. And some elected officials may wonder why at a time when the Fed has acknowledged its rate hike campaign will put some Americans out of work and cause economic pain, it is paying banks and money funds, many of them foreign, just to park cash on the sidelines.

Fed Chair Jerome Powell “might have a lot to answer for” when he testifies before Congress early next year on monetary policy, said Derek Tang, an economist at forecasting firm LH Meyer.

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