The Fed Books a Loss of $126B in February

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The Federal Reserve came close but still fell short of its $95 billion per month balance sheet reduction target through the last full week in February. This means the Fed has fallen short in 8 of the last 9 months.

And with rising interest rates coupled with even this modest balance sheet reduction, the Fed is also bleeding money.

While the roll-off of Treasuries seems to be going as planned, the Fed has been completely unable to unload mortgage-backed securities (MBS). The current target is $35B a month, but the Fed has been nowhere near that amount. In the latest month, only $4.5B in MBS rolled off the balance sheet.

Figure: 1 Monthly Change by Instrument

The table below details the movement for the month:

• The Fed was clearly focused on the short end of the curve, perhaps hoping to not push up long rates too much

  • The Fed surpassed the $60B target in Treasuries

  • Other added to the reduction by $12.6B, but this was still not enough to hit the $95B target

Figure: 2 Balance Sheet Breakdown

Looking at the weekly data shows that activity has been more sporadic in the last two weeks in Treasuries. Activity in MBS has been almost non-existent.

Figure: 3 Fed Balance Sheet Weekly Changes

As the Fed continues to miss on the MBS reduction, the overall portfolio allocation of MBS has grown. MBS now makes up 31.3% of the balance sheet. Also, surprising is the surge in 10+ year maturity. Is the Fed quietly relaunching operation twist to contain the long end of the curve?

Figure: 4 Total Debt Outstanding

Operation Twist would seem unnecessary given the inversion in the yield curve. Then again, the entire yield curve has become a jumbled mess, so maybe the Fed just doesn’t know what to do at this point. The recent spike in yields has brought the 10-year back towards 4% while the 2-year approaches 4.7%.

Figure: 5 Interest Rates Across Maturities

The yield curve inversion between 10 and 2-year notes reached -83bps on Feb 14th, matching the low seen back on December 7th.

Figure: 6 Tracking Yield Curve Inversion

The chart below shows how the yield curve has moved up over the last month. The curve compared to 1 year ago is quite dramatic!

Figure: 7 Tracking Yield Curve Inversion

A lost Revenue Source for the Treasury

With the Fed now dealing with higher rates and liquidating its balance sheet, the losses are really starting to pile up. The Fed lost $126B in February. For perspective, the largest yearly gain over the last 10 years came in 2021 with a gain of $104B. Yes! You read that correctly, the Fed is now losing more in a month than it was earning for an entire year!

According to Reuters, the Fed has been warning about this possibility for some time. That doesn’t change that these are massive losses! It should be noted, the Fed will not send the Treasury a bill to cover its losses. Instead, it will book the losses into a deficit account that will be held until the Fed makes enough money to make up for its losses.

Figure: 8 Fed Payments to Treasury

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