High-Interest Rates May Cause Problems For Fed

The New York Fed says that if interest rates go up, the Federal Reserve might lose more money and temporarily stop sending money to the US Treasury Department. This could reduce an important source of funds for the government.

The New York Fed reported that the loss of income is because the Federal Reserve is working to create jobs and keep prices stable. They believe the income will eventually come back.

Federal Reserve presidents have recently shared their views on interest rates. Philadelphia Federal Reserve Bank President Patrick Harker said that the U.S. central bank might soon be done raising interest rates a year into its most rapid monetary policy[1]. On the other hand, Federal Reserve policymakers signaled their intention to continue with more interest rate hikes, with some supporting a top policy rate of at least 5%.

Federal Reserve Chairman Jerome Powell warned that the central bank might have to push interest rates higher than previously expected to curb stubborn inflation. Regional president George said that interest rates should be held above 5% well into 2024. San Francisco Federal Reserve President Mary Daly expects the central bank to raise interest rates by at least another percentage point, and possibly more, before considering a pause.

The Federal Reserve has already raised interest rates by a quarter of a point, which affects a wide range of consumer finances like mortgages, credit cards, and student loans. The Federal Open Market Committee (FOMC) is responsible for making decisions about interest rates and the Federal Reserve’s asset holdings. The FOMC consists of twelve members, including the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

The Fed’s latest move has brought the federal funds rate to a range of 4.75% to 5%, which is expected to further slow economic activity as it drives up rates for credit cards, adjustable-rate mortgages, and other loans. The fed funds rate is the interest rate banks charge each other to lend Federal Reserve funds overnight, and the nation’s central bank uses it in addition to other tools to promote economic stability by raising or lowering the cost of borrowing.

Last month, the Fed revealed it had stopped sending money to the Treasury in 2022, causing a $16.6 billion delay. Payments to the Treasury fell to $76 billion, compared to $109 billion the year before.

To fight high inflation, the Fed increased interest rates over the past year, raising its main rate to a target range of 4.75% to 5%. The central bank started lowering its holdings last year and is now doing it at a rate of up to $95 billion monthly.

Because of the rate increases, the Fed now pays more interest on its debts. These payments became bigger than the interest the Fed gets from its bond holdings in September 2022, leading to losses that could eventually result in more Treasury debt.

Other key points include:

  • A $1.08 trillion loss for the domestic portfolio due to higher market interest rates, compared to a $127.9 billion gain in 2021.
  • The Treasury portfolio’s loss dropped to $672.8 billion in 2022, from a $134.6 billion gain in 2021.
  • The average length of Treasury securities held by the Fed is longer than the average length of all outstanding Treasury securities (7.9 years vs. 6.2 years).
  • The central bank expects its portfolio to shrink until mid-2025, with monthly reductions averaging around $80 billion.
  • The use of the reverse repo facility grew in 2022 because it was more attractive compared to other short-term money market rates and a preference for shorter-term investments. The Fed expects balances to decrease to a minimal level by the end of 2025, at a rate similar to the reduction of the balance sheet.
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