NY Fed Report Sees Several More Years Of Balance Sheet Contraction

The Federal Reserve is on a path to shrink the size of its massive stock of cash and bonds for several more years, and will likely also face several more years of negative net income as well, a report from the New York Fed said Tuesday.

As part of the annual report for its System Open Market Account for 2022, the bank said that Fed holdings, which now stand at $8.7 trillion, will likely fall to around $6 trillion by the middle of 2025 before holding steady for around a year. Holdings are then expected to grow to maintain balance with the growth of the economy and tick back up to $7.2 trillion by 2030.

As part of an effort to cool inflation with what have been rapid increases in its short-term rate target, the Fed has complemented that work with a process begun last summer to shrink the size of its SOMA holdings.

Aggressive purchases of Treasury and mortgage bonds kicking off at the onset of the coronavirus pandemic in March 2020 more than doubled the size of the SOMA, which peaked last summer at just shy of $9 trillion. The Fed is now allowing just shy of $100 billion per month in bonds it owns to expire and not be replaced.

The New York Fed report also offered projections of the net negative income situation the institution faces as part of its efforts to raise rates. Lifting the federal funds rate target from near zero levels to the current 4.75% to 5% range has sharply increased central bank interest rate costs and is now outstripping the income it earns from services and interest on bonds it owns.

While the Fed was still able to hand back excess profits to the Treasury in 2022, its income turned negative late last year. The Fed captures this situation with what it calls a deferred asset, an accounting measure that records the loss which will then be covered when the Fed returns to profitability.

"The projections for negative net income suggest that remittances to the U.S. Treasury will be suspended for some time, and that the deferred asset recorded on the Federal Reserve's balance sheet reflecting the accumulated net loss will continue to grow," the report said.

As of April 5, the Fed's deferred asset stood at $46.2 billion. The Fed has stressed that its losses do not affect its ability to conduct monetary policy, although some analysts have worried the situation could create trouble with elected leaders.

The report also noted that the Fed still expects that substantial usage of its reverse repo facility, which has taken in $2 trillion per day or more from money market funds and other firms for many months, should contract over time, in part due to money managers gaining greater certainty over the economic outlook.

The Fed's efforts to reduce the size of its balance sheet have been set back in recent weeks by a surge in banks seeking central bank liquidity in the wake of the failure of Silicon Valley Bank. The Fed extended $323.3 billion in credit via three of its lending efforts as of last Wednesday, up from just under $5 billion at the start of March. But central bankers and analysts have cautioned that the resulting expansion of the balance sheet due to this lending is not stimulative to the economy.