After three years of unprecedented losses tied to pandemic era policies, the central bank shows early signs it may soon return profits to the Treasury.
The Federal Reserve appears to have reached a turning point after three years of losing money, a rare financial predicament stemming from the unorthodox monetary policies deployed during the pandemic. Recent data suggests America’s central bank has begun the long road back to profitability, though the journey ahead may stretch for years.
The evidence lies in an obscure accounting line item that few outside financial circles pay attention to. Since early November, the Fed’s deferred asset, an internal tally of accumulated losses, has begun shrinking for the first time since the red ink started flowing in September 2022. The number dropped from $243.8 billion to $243.2 billion between November 5 and November 26. While that $600 million improvement seems modest against the massive total, it marks a significant reversal in trajectory.
How the Fed ended up losing billions
Understanding the Fed’s unusual financial predicament requires rewinding to the pandemic’s early days. When coronavirus lockdowns threatened to freeze credit markets and crater the economy, the central bank launched an aggressive bond purchasing campaign. The goal was straightforward: buy massive quantities of Treasury bonds and mortgage securities to push down longer term interest rates and keep money flowing through the financial system.
The strategy worked, but it came with consequences. Fed holdings ballooned from around $4 trillion to a peak near $9 trillion by summer 2022. The central bank was suddenly sitting on an enormous portfolio of bonds paying relatively low interest rates, a collection assembled when borrowing costs were near historic lows.
When inflation forced an uncomfortable pivot
The trouble began when inflation surged to levels not seen in four decades. The Fed responded by aggressively raising interest rates starting in early 2022, eventually pushing its benchmark rate to between 5.25 and 5.5 percent by 2023. That created an awkward mismatch. The Fed was earning modest returns on its older, low yielding bonds while simultaneously paying banks much higher rates on reserves they parked at the central bank, a key mechanism for controlling short term interest rates.
The math turned punishing. Every week, the Fed was paying out more than it was taking in. Losses accumulated in the deferred asset account, essentially an IOU the central bank owes to the Treasury Department.
Why Fed watchers see reasons for optimism
Recent interest rate cuts have fundamentally altered the equation. With the Fed’s benchmark rate now sitting between 3.75 and 4 percent, and additional cuts likely on the horizon as policymakers worry about labor market softness, the gap between what the Fed earns and what it pays has narrowed considerably.
Bill Nelson, a former senior Fed official who now serves as chief economist for the Bank Policy Institute, estimates that by analyzing regional Fed bank performance, the combined system appears on track to generate more than $2 billion in profits during the current quarter. That would mark a stark contrast to the steady drumbeat of losses that characterized the past three years.
Derek Tang, an analyst at LHMeyer, noted that the bleeding appears to have stopped around the same time the Fed cut interest on reserve balances by 25 basis points in October. The timing suggests the negative carry that plagued the central bank has finally ended.
Matthew Luzzetti, chief US economist at Deutsche Bank, pointed out that as market yields began rising above the rate the Fed pays on reserves, the conditions for profitability returned. The central bank should theoretically start earning more than it pays out.
The long road to Treasury repayments
Fed watchers universally agree that returning to regular Treasury remittances will take considerable time. The central bank must first work through its entire deferred asset balance before it can resume the profit transfers that federal law requires. Given the enormous sum involved and the relatively modest pace of improvement so far, that process will likely span multiple years.
Does it actually matter
Fed officials have consistently maintained that profits and losses carry no implications for the central bank’s ability to conduct monetary policy. The institution can create money as needed to implement its decisions regardless of its financial position.
Yet the losses have drawn criticism from some lawmakers who view the interest payments to banks as an unnecessary subsidy to the financial sector. As the Fed inches back toward profitability, that political pressure may gradually ease, allowing the central bank to focus on its core mission of managing inflation and employment without fielding questions about its own balance sheet.