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Tightening Monetary Policy Will Put a Hole in the Fed's Balance Sheet

October 23, 2022 at 3:00 am ET

On

Oct. 5, the Fed held almost $4.85 trillion in fixed-income treasury securities (excluding short-term bills and inflation-indexed securities) and another $2.7 trillion in mortgage-backed securities. If these securities were marked to market, the drop in their value would far outweigh the capital of the Fed. Duration (not to be confused with the related concept of maturity) is the measure that links the change in market prices to the change in yields. If for illustrative simplicity (and, perhaps, somewhat conservatively) one assumes a portfolio duration of five years, the mark-to-market loss on a portfolio of $7.5 trillion is about $375 billion for every percentage point increase in the yield. But for some creative accounting, the numbers in the balance sheet shown might call into question the solvency of the Fed—although, insofar as the Fed can create dollars, it can never actually be insolvent.

[Troubling balance-sheet implications for both private financial institutions and central banks have received less attention. On the one hand, if central banks fail to quell inflation and inflation expectations—because of actual or perceived irresolution or exogenous shocks—yields on long-dated assets will rise. The consequent capital losses for bondholders may spark financial ructions—again, the recent diminution of collateral required by U.K. pension funds is a telling example. On the other hand, the tightening of monetary policy will, itself, create a hole in central-bank balance sheets.

Like the ECB and the Bank of England, the Fed is operating in an environment of extraordinary uncertainty.

Full @

https://www.marketwatch.com/articles/fed-balance-sheet-rate-hikes-51666468799?mod=newsviewer_click