Fed enters ‘uncharted territory’ as assets hit $3 trillion

‘Evenly Divided’

The minutes from the Federal Open Market Committee’s Dec. 11-12 meeting show participants were “approximately evenly divided” between those who said it would be appropriate to end the purchases around mid-2013 and those who said they should continue beyond that date. A number of policy makers are concerned the size of the Fed’s holdings “could complicate the Committee’s efforts to eventually withdraw monetary policy accommodation,” according to the minutes.

The central bank’s balance sheet has provided record windfalls to the U.S. Treasury. The Fed uses interest income from its bond holdings to cover its own expenses and sends the rest to the Treasury. In 2012, that dividend to taxpayers was $88.9 billion.

One risk from a large balance sheet is the possibility that the Fed’s interest income could evaporate in coming years as interest rates rise, according to a paper written by Fed researchers and released last week.

Rising Rates

The five economists and assistants in the central bank’s monetary affairs division describe in their paper the impact of rising interest rates on the Fed’s portfolio. After reviewing various scenarios they conclude that the Fed’s payments to Treasury “will likely decline for a time, and in some cases fall to zero.”

If interest rates rise more quickly than expected, the central bank may go years without remitting money to Treasury, according to the researchers.

The S&P 500, the benchmark for U.S. equities, climbed for the eighth day in a row, giving the index its longest winning streak since 2004. The S&P 500 added 0.3 percent to 1,498.80 at 11:12 a.m. in New York.

“We’re going to boldly go where no central bank has gone before,” said Brian Jacobsen, who helps oversee $210 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “So it’s full speed ahead.”

The central bank’s balance sheet is now more than triple its size before the financial crisis. Fed assets stood at $924 billion on Sept. 10, 2008, the week before the bankruptcy of Lehman Brothers Holdings Inc. helped spark a global financial crisis.

The Fed responded to the financial crisis first with emergency credit programs, and then with bond purchases known as QE or quantitative easing. In the first round of purchases, the Fed bought $1.7 trillion of securities. In a second round of QE, begun in November 2010, the central bank added an additional $600 billion of Treasuries to its holdings.

Bloomberg News

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