Bloomberg News reports that it appears that the Federal Reserve is on the way to losing out the money in the next year as it is raising the short-term rates of interest to try to tame inflation, according to William Dudley. He was a former New York Fed President.
The Impacts of Interest Hike
The main reason is that the rate of interest that the Fed will be shelling out to the banks for the reserves they are holding at the central bank will be more than the rate it is expected to earn on the huge holdings of Treasury and the mortgage-backed securities.
While the losses that are expected to be incurred will not affect the ability of the Fed to carry out monetary policy, it will dissuade the policymakers from disposing of the mortgage-backed securities because, in that case, it would add to the red ink, as revealed by Dudley during a webinar on Thursday, one that the Official Monetary and Financial Institutions Forum sponsored.
The Fed Chairman Jerome Powell, along with his colleagues, hiked the rates on Wednesday by 75 basis points, which is the biggest hike since 1994, and said that there would be further hikes for the balance of the current years and even into the next. The rates are now seeing to rise to 3.4% by the end of the year, and by the end of 2023, it is likely to become 3.8%, as per the median projection, from a present target of 1.5% to 1.75%.
Bloomberg News reports that Dudley, associated with Bloomberg Economics as an adviser, says that if this trajectory is maintained, the Fed will undoubtedly lose money in the next calendar year of 2023.
Under that circumstance, the Treasury would be creating a so-called deferred asset on the Fed’s balance sheet so that the central bank will not be required to deplete its capital, said Dudley. He also said that there would be no effect on monetary policy implementation.
Aside from hiking interest rates to tame inflation, the Fed is also decreasing the mammoth balance sheet by not replacing those securities it holds once they mature. It is also being said that there is a possibility of selling some of the mortgage-backed securities as part of the effort of the Fed to trim down its balance sheet.
Dudley also anticipates that the Fed losing a lot of money would give rise to a “fierce debate” related to the past use of quantitative methods of easing the economy by the Fed. Dudley says it could be a disaster if they win the debate. The opponents of QE are likely to seize on the losses and argue that the Fed must not buy longer-dated securities.
