(Bloomberg) — Profits and losses are not usually thought of as a consideration for central banks, but rapidly mounting red ink at the Federal Reserve and many peers risks becoming more than just an accounting oddity.
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The bond market is enduring its worst selloff in a generation, triggered by high inflation and the aggressive interest-rate hikes that central banks are implementing. Falling bond prices, in turn, mean paper losses on the massive holdings that the Fed and others accumulated during their rescue efforts in recent years.
The rise in rates is also involved in the central banks paying more interest on the reserves that commercial banks park with them. This has put 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 make a loss in the Bank of England.
Britain’s move highlights a dramatic shift in countries including the US. The US
The accounting losses threaten to fuel criticism of the asset purchase programs undertaken to save markets and economies, most recently when Covid-19 shattered large swathes of the global economy in 2020. Together with the current outbreak in inflation, that could prompt calls to clean up in The independence of monetary policy makers, or limit what steps 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 political backlash central banks are likely to increasingly face,” said Jerome Haegeli, chief economist at Swiss Re, who previously worked in Switzerland. central bank.
The following figures illustrate the scope of operating losses or mark-to-market balance sheet losses currently materializing:
Fed remittances owed to the U.S. A negative number amounts to an IOU that would be repaid by any future income.
The Reserve Bank of Australia posted an accounting loss of $36.7 billion ($23 billion) for the 12 months to June, leaving it with a $12.4 billion negative-equity position.
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 reported a loss of 95.2 billion francs ($95 billion) for the first six months of the year as the value of its foreign assets fell — the worst first-half performance since it was founded in 1907. .
Although for a developing country, losses in the central bank can undermine confidence and contribute to a general exodus of capital, this kind of credibility challenge is not likely for a rich nation.
As Seth Carpenter, chief global economist for Morgan Stanley and a former US Secretary of State,
RBA Deputy Governor Michele Bullock said in response to a question last month about the Australian central bank’s negative-equity position that “we don’t believe we are impacted in our ability to operate.” After all, “we can make money. That’s what we did when we bought the bonds,” she noted.
But there can still be consequences. Central banks have already become politically charged institutions after failing, by their own admission, to anticipate and act quickly against incipient inflation over the past year or more. Incurring losses adds another magnet for criticism.
For the European Central Bank, the possible loss comes after years of buying government bonds, despite the reservations of conservative officials who argue that they have strengthened the lines between money and fiscal policy.
With inflation running at five times the ECB’s target, pressure is mounting to release bond holdings – a process called quantitative tightening that the ECB is now preparing for even as the economic outlook darkens.
“Although there are no clear economic constraints to the central bank running losses, there is the possibility that these become more of a political constraint on the ECB,” Goldman Sachs Group Inc. Economists George Cole and Simon Freisenet said. Especially in northern Europe, it “could fuel the discussion of quantitative tightening.”
President 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 profits are not part of central banks’ remit, saying that fighting inflation remains the “sole goal of policymakers.”
The Bank of Japan remains for now, because it did not raise interest rates and still imposed a negative rate on a portion of the bank’s reserves. But things could change when Governor Haruhiko Kuroda steps down in April, and his successor is confronted with 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 this authority back in 2008 to help the Fed control interest rates. Since the Fed is now taking losses, and the Republicans may have taken control of at least one chamber of Congress in the November midterm elections, the debate may arise again.
The Fed’s turnaround may be particularly notable. After paying as much as $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 in December — as markets expect — Estimates Stephen Stanley, chief economist for Amherst Pierpont.
Without the Fed’s income, the Treasury then needs to sell more debt to the public to fund government spending.
“This may be too weird to hit the public’s radar, but a populist could spin the story in a way that would not reflect well on the Fed,” Stanley wrote in a note to clients this month.
– with help from Garfield Reynolds.
(Adds reference to Bank of Japan after ‘BOJ, Fed’ subheadline.)
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