Last week, two main events jarred the markets and pushed the S&P 500 index to its worst weekly performance since late October 2023.
The first was the hotter-than-expected March Consumer Price Index (CPI). Both headline and core CPI rose by 0.4% month-over-month in March.
That’s the opposite of what the Federal Reserve wants to see.
This weekend’s escalation of fighting in the Middle East will only increase near-term inflation, especially in the oil markets.
That’s regardless of whether the Fed considers this price escalation when weighing its thoughts on the core PCE inflation rate.
(Remember, core PCE is the Fed’s favorite inflation measure. But it excludes energy prices, as we’ve discussed here and here.)
Second, the Fed released minutes from its March Federal Open Market Committee (FOMC) meeting. It noted inflation has improved, but it’s not at the Fed’s target of 2% yet.
Investors reacted by pushing back rate cut expectations from June to July. This confirms what we’ve said for months: that July would be the likely timeframe for what I call a “Stage 3” pivot to rate cuts.
As regular readers here know, I don’t believe the Fed has any control over critical prices that impact your daily life, from gas at the pump to the cost of your morning orange juice.
Yet, we are supposed to believe the Fed can impact inflation more than geopolitical tensions or supply chain pressures can.
Why? Because the Fed’s dual mandate is to keep both employment levels and prices steady.
But here’s the irony in that. The Fed’s own finances are a mess.
Let me explain.
The Fed’s Annual Report Card
Earlier this month, the Fed released the results of its annual 2023 financial audit. I’ll cut to the chase – these results weren’t good.
In its annual financial audit press release, the Fed said: “The Reserve Banks’ 2023 sum total of expenses exceeded earnings by $114.3 billion.”
That figure was $2 billion better than its estimate at the start of the year, which you can see in the graph below. But that’s not saying much.
In contrast, in 2021, the Fed had a net income of $109 billion.
That reflected the difference between what it gains on interest payments it receives vs. what it is supposed to give (or, in Fed speak, “remit”) to the U.S. Treasury Department.
In 2022, its net income was $59.4 billion.
The Federal Reserve Act of 1913 requires the Fed’s member banks to remit, or pay, their excess earnings to the U.S. Treasury through the Fed.
Excess earnings are earnings left over once banks take care of operating costs, dividend payments, and money they are required to set aside for emergencies.
The problem is that if bank earnings aren’t enough to cover those costs, they can’t remit excess earnings to the Fed. Then, the Fed can’t make those payments to the U.S. Treasury.
Bank earnings that came out last week, and will continue this week, were mixed at best. That doesn’t bode well for the Fed’s own finances and its ability to get more money in excess earnings from Wall Street this quarter.
Losses due to unremitted bank earnings keep escalating. And they are a result of the Fed’s own policy of jacking up rates, which began in March 2022 and leaving them at their current levels.
That policy is like a mini backdoor bank bailout for Wall Street banks.
Let’s dig deeper.
The Fed Is Losing Money in Many Ways
As of April 11, the Fed has racked up $163 billion in total losses. That includes the $114 billion gap between interest it takes in and required remittance. Those losses also reflect operating losses.
The Fed receives interest from the U.S. Treasury securities that it holds. It bought those securities (or bonds) by deploying quantitative easing (QE) policies.
That entailed the Fed printing money from thin air and buying Treasury or Mortgage securities with it.
The Fed bought most of the treasuries it held when rates were lower.
The Fed’s audit reported that the total amount of interest it received on those securities was $163.8 billion in 2023. That’s a decrease of $6.2 billion of interest coming in compared to 2022.
Doing the math, the Fed received a 2.2% interest rate on its $6.97 trillion of securities.
However, the Fed must pay interest on the reserves that Wall Street banks hold with the Fed. That interest rate is 5.4%.
As the Fed’s audit revealed, the cost of paying that interest was $176.8 billion in 2023. That was a huge increase of $116.4 billion from 2022.
And that’s not the only interest cost the Fed must pay that’s higher than the interest amount it makes.
The Fed must also pay 5.3% interest on its “reverse repo” operations.
“Reverse repo” is when Wall Street banks lend their Treasuries, overnight or for up to one month, to the Fed. They do this in return for short-term cash loans.
The Fed’s interest expense on those was $104.3 billion in 2023. That was $62.4 billion higher than in 2022.
Now, you have to pay interest on deferred taxes to the IRS. But the Fed can use a backdoor accounting gimmick to defer its payments to the U.S. Treasury at no cost.
It does that through an accounting maneuver called “recording a deferred asset.” It’s like the Fed crafting an IOU to the Treasury Department – with no fee. In 2023, that deferred asset amount rose by $116.7 billion.
Despite mounting losses, the Fed voted to keep rates at 5.25% at its last meeting. That means the gap between what it earns and what it needs to pay in interest remains high.
And there’s another wrinkle…
Fed Minutes Show Liquidity Concerns Rising in the Banking Sector
To make matters worse, the banking system is on shaky ground.
The Fed minutes from the March 19-20 FOMC meeting showed even the Fed is beginning to pay more attention to this.
The minutes included the standard comments about inflation trending down but not at 2% yet.
But the Fed also expressed concern about “the challenges faced by the regional banking sector, particularly that sector’s exposures to commercial real estate (CRE).”
Regular readers know that we have been stressing this growing banking problem for months.
That’s why the Fed also discussed how to deal with its $7.5 trillion book of assets. The topic of slowing down what’s called the “runoff” of assets on their book came up at the last meeting.
The main reason the Fed gave was to reduce the “probability that money markets experience undue stress that could require an early end to runoff.”
That’s Fed speak for the Fed being concerned about a potential liquidity crisis in the banking sector.
What This Means for Your Money Today
Here’s how and why this all matters to you and your money.
Taxpayers are paying for the Fed’s losses.
When the Fed is making money – as it did until September 8, 2022 – it is required to turn its excess earnings over to the U.S. Treasury Department. That’s the law.
Doing so, all other factors equal, reduces the amount of money that the U.S. government needs to borrow by at least that amount.
But the more the Fed slips into the red, the greater the shortfall to the U.S. Treasury. And the more likely it is for the government to sink further into debt to make up the difference.
Now, there’s some good news. You don’t have to be defenseless against the Fed’s mismanagement of its book and contribution to more debt.
You can take steps to protect your wealth today. And your best protection is to hedge against the inflation the Fed can’t control.
The best way to do that is to park some of your wealth in assets that the Fed can’t print. Two such assets are gold (which already hit my first 2024 target of $2,400 an ounce) and Bitcoin.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins