Fed carrying $330 billion in unrealized losses on its assets according to Q1 financial statement

[May 27, 2022]  WASHINGTON (Reuters) - The U.S. Federal Reserve is carrying $330 billion in unrealized losses on its holdings of U.S. Treasury and mortgage-backed securities as of the end of March, according to newly released financial statements showing the impact of rising interest rates on the market value of the Fed's balance sheet.

The central bank's holdings of nearly $9 trillion in assets still allowed the Fed to remit $32.2 billion to the U.S. Treasury in the first quarter of 2022, according to the documents.

But the losses on the Fed's investments, an $8.5 trillion portfolio that surged higher through asset purchases designed to keep financial markets stable through the pandemic, pose a potentially tough political problem for the central bank.

Bill Nelson, chief economist at the Bank Policy Institute, said that adjusting for the appreciation in its assets the Fed had seen through the end of last year, the unrealized losses were an even larger $458 billion.

Criticized for continuing to buy assets even as the economy was well on the way to healing from the pandemic, it is now trying to reverse course and shrink its holdings, particularly of mortgage backed securities.

If it chooses to speed the process by selling some of those assets, the unrealized "paper" losses would have to be booked as a tangible hit.

According to the Fed's first quarter financial statement, the Fed's $2.77 trillion in MBS purchases has declined on a fair market value basis by $164 billion, and as of March 31 was worth $2.606 trillion.

The Federal Reserve building is seen before the Federal Reserve board is expected to signal plans to raise interest rates in March as it focuses on fighting inflation in Washington, U.S., January 26, 2022. REUTERS/Joshua Roberts

Mortgage rates are even higher now, and as with any interest-bearing security as market interest rates have risen those losses have deepened.

A New York Fed report earlier this week flagged potentially large losses to the Fed's portfolio, given that interest rates are expected to continue rising.

The report also flagged a further issue: As the Fed raises its short term interest rate, it will do so by offering larger payments to banks for the reserves they deposit at the Fed, increasing the central bank's expenses. As its balance sheet shrinks, meanwhile, its interest earnings will decline, potentially pushing the Fed towards operating losses.

New York Fed officials in the report said the Fed would be able to fund its operations and conduct monetary regardless.

But it could mean sharp declines in a key metric watched closely by elected official: the profits that the central bank remits to the U.S. Treasury.

Those have climbed during the era of "quantitative easing" and hit a record $107 billion last year, but could fall to zero as Fed monetary policy shifts.

(Reporting by Howard Schneider; Editing by Leslie Adler and Diane Craft)

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