The Federal Reserve's book loss has exceeded the $200 billion mark, and it must "significantly" cut interest rates next year

Negative numbers are reflected in the accounting metrics known as deferred assets at the Federal Reserve. The Fed must first make up for this shortfall before it can begin returning excess profits to the U.S. Treasury.

The Fed's losses stem from its high-interest rate monetary policy path that it has been pursuing to reduce inflation. The Fed pays fees to banks and money market funds that hold cash at the central bank to keep short-term rates at desired levels.

The Fed fell into a deficit two years ago and faces a record deficit in 2023 as the funds it must pay to manage rates exceed the interest it earns from the bonds it holds.

The Fed funds itself through services provided to the banking system and interest on the bonds it holds. It is required by law to return all profits to the Treasury, and over the years, it has returned a significant amount of funds. Research from the St. Louis Fed shows that from 2011 to 2021, the Fed returned nearly $1 trillion to the Treasury.

This deficit situation is related to the aggressive rate hike cycle from March 2022 to July 2023 when the Fed's rate target soared from near zero to between 5.25% and 5.5%.

In March, the Fed reported a total book loss of $114.3 billion last year. It paid $176.8 billion to banks, $104.3 billion through reverse repurchase agreements, and earned $163.8 billion through bond interest on its balance sheet.

With the recent 50 basis point rate cut by the Fed and further easing prospects, the pace of future loss growth may slow as the interest expense level needed to maintain rate targets decreases. However, before the Fed can return cash to the Treasury, it must effectively repay deferred assets, which may take several years.

So far, the Fed's financial situation has not faced any political pressure, surprising some, including former Fed officials.

Chicago Fed President Guersby reiterated on Thursday that rates need to be "substantially" lowered next year.

Guersby emphasized how the Fed's narrow focus on inflation has expanded to the job market and added that he hopes to prevent the current 4.2% unemployment rate from rising further. Guersby said in an interview with Chicago public radio station WBEZ on Thursday, "Inflation is coming down, close to target, unemployment is rising, and the job market is basically where we want it. Rates need to be substantially lowered in the next 12 months."

Fed watchers are now turning their attention to policymakers' meeting in November. While last month's forecasts suggested officials may opt for a slight 25 basis point rate cut at the final two meetings of the year, the extent of the rate cut will depend on how the economy evolves