The Federal Reserve Has Engineered a Recess of its Asset Hemorrhaging

It’s a well-known secret that the Federal Reserve has been losing $Billions under its quantitative tightening (QT);  it’s greatest losses ever. The last time the Fed lost money was 1915, but the Fed says it doesn’t matter because it’s all baked in to its “Deferred Assets”, the Fed’s IOU to itself – actually to taxpayers. An inverted yield curve caused payments on the Fed’s liabilities to exceed receipts on its assets. Expenses exceeded revenues.

To stop the hemorrhaging, the Fed has engineered a return to a normal yield curve that is not inverted by continuing to let the market set long bond rates. Instead of stepping in to buy long-term Treasuries as it has under quantitative easing (QE), the Fed is allowing its bond holdings to mature without replacement – winding the Fed balance sheet down from $9 trillion to $7 trillion.

Short term rates are going down because the Treasury is issuing them at lower rates while long term rates are going up because the Fed is not intervening.

A Vicious Cycle

The Fed is trapped in a vicious cycle, as shown in the following. Can you see a way out? It’s like the roundabout in National Lampoon’s European Vacation. In this recent loop, the Fed has succeeded in reducing its balance sheet. Before QE, the Fed typically held $1 trillion, but that escalated to $9 trillion under QE. These balances evidence the degree of the intervention required to control interest rates under a Zero Interest Rate Policy (ZIRP).

Conclusion

It's interesting to note that in this current loop a stock market correction was avoided. Rising interest rates did not reduce stock prices. It’s conceivable that investors are bidding up stock prices as an inflation hedge, or it may be that Artificial Intelligence is the new Dotcom when prices could grow to the sky.

Instead of reacting to a market correction as it did in the 2013 Taper Tantrum, the Fed moved to reduce rates because inflation appears to be under control. It has stimulated an economy that is growing. The economy doesn’t need stimulation, so overheating could happen. We will see.

Here we go again.

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