(Bloomberg) – Profits and losses aren’t usually seen as a consideration for central banks, but the rapidly rising red ink at the Federal Reserve and many peers risks becoming more than just an accounting quirk.
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The bond market is suffering its worst selloff in a generation, triggered by high inflation and aggressive interest rate hikes implemented by central banks. Falling bond prices, in turn, mean paper losses on the massive holdings the Fed and others have accumulated in their bailout efforts in recent years.
Rate hikes also mean that central banks pay more interest on reserves than commercial banks store with them. That tipped the Fed into operating losses, creating a hole that could ultimately force the Treasury Department to fill in through debt sales. The UK Treasury is already preparing to make up for a loss at the Bank of England.
Britain’s move highlights a sea change in countries like the United States, where central banks are no longer major contributors to government revenue. According to Amherst Pierpont Securities LLC.
Accounting losses threaten to fuel criticism of asset purchase programs undertaken to save markets and economies, most recently when Covid-19 shut down large swaths of the global economy in 2020. Coinciding with the current surge inflation, this could create an incentive to curb the independence of monetary policy makers or limit the actions they can take in the next crisis.
“The problem with central bank losses is not the losses per se – they can always be recapitalized – but the negative political reactions that central banks are increasingly likely to face,” said Jerome Haegeli, economist in head at Swiss Re, who previously worked for Switzerland. Central bank.
The following figures illustrate the scope of mark-to-market operating losses or balance sheet losses that are now materializing:
Fed remittances due to the US Treasury reached a negative $5.3 billion as of October 19, a stark contrast to positive numbers seen as recently as late August. A negative number equals an IOU that would be repaid through any future income.
The Reserve Bank of Australia posted a book loss of A$36.7 billion ($23 billion) for the 12 months to June, leaving it with a negative equity position of A$12.4 billion .
Dutch central bank governor Klaas Knot warned last month that he expects cumulative losses of around 9 billion euros ($8.8 billion) for the coming years.
The Swiss National Bank posted a loss of 95.2 billion francs ($95 billion) for the first six months of the year as the value of its foreign currency holdings fell – the worst first-half performance since its inception in 1907.
While for a developing country central bank losses can undermine confidence and contribute to a general outflow of capital, this kind of credibility challenge is not likely for a wealthy nation.
As Seth Carpenter, chief global economist for Morgan Stanley and former US Treasury official, put it: “The losses don’t have a significant effect on their ability to conduct short-term monetary policy.”
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 we’re affected at all in our ability to operate. “. After all, “we can create money. That’s what we did when we bought the bonds,” she noted.
But there can still be consequences. Central banks had already become politically charged institutions after having, by their own admission, failed to anticipate and act quickly against nascent inflation for the past year or more. Incurring losses adds another magnet to criticism.
For the European Central Bank, the potential for mounting losses comes after years of government bond purchases made despite reservations from conservative officials saying they have blurred the lines between monetary and fiscal policy.
With inflation five times above the ECB’s target, pressure is mounting to shed bond holdings – a process called quantitative tightening that the ECB is now bracing for even as the economic outlook darkens.
“While there are no clear economic constraints to central bank losses, it is possible that these will become more of a political constraint for the ECB,” said Goldman Sachs Group Inc. economists George Cole and Simon Freycenet. Particularly in Northern Europe, this “could fuel the discussion on quantitative tightening”.
Chairman Christine Lagarde gave no indication that the ECB’s decision on QT will be driven by the prospect of incurring losses. She told lawmakers in Brussels last month that generating profits was not part of central banks’ job, insisting that tackling inflation remained the “sole objective” of policymakers.
The Bank of Japan remains on the sidelines for now, having not raised interest rates and still imposing a negative rate on part of the banks’ reserves. But things could change when Governor Haruhiko Kuroda steps down in April and his successor faces historically high inflation.
As for the Fed, Republicans have in the past expressed opposition to its practice of paying interest on excess bank reserves. Congress granted this authority in 2008 to help the Fed control interest rates. With the Fed now suffering losses and Republicans potentially taking control of at least one chamber of Congress in November’s midterm elections, the debate could resurface.
The Fed’s U-turn could be particularly notable. After paying up to $100 billion to the Treasury in 2021, it could face losses of more than $80 billion on an annual basis if policymakers raise rates by 75 basis points in November and 50 basis points base in December – as markets anticipate – estimates Stephen Stanley, chief economist for Amherst Pierpont.
Without Fed revenue, the Treasury must then sell more debt to the public to fund government spending.
“It may be too mysterious to hit the public radar, but a populist could spin the story in a way that doesn’t reflect the Fed well,” Stanley wrote in a note to clients this month.
–With the help of Garfield Reynolds.
(Adds a reference to the Bank of Japan after the “BOJ, Fed” subheading.)
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