Federal Reserve Poised to End Historic Loss Streak

The Federal Reserve is nearing the end of its longest period of financial losses, according to a report from Morgan Stanley. Analysts believe the central bank may soon return to profitability and resume sending surplus funds to the U.S. Treasury.

The losses began in 2022 after rapid interest rate hikes increased the Fed’s expenses. For the first time in decades, it was paying out more in interest than it was earning from bonds.

Morgan Stanley Identifies Fed’s Breakeven Rate

Morgan Stanley estimates the Federal Reserve’s breakeven rate is now around 4.8%. This figure is based on the weighted average coupon of Fed-held bonds and its interest liabilities.

“As of March 12, the weighted average coupon was 2.66%, and liabilities from reserves and reverse repos made up 55% of the Fed’s balance sheet,” the report stated.

Lower short-term rates and a smaller balance sheet are helping the Fed inch back toward positive territory.

From Red Ink to Black: Fed’s Financial Snapshot

In 2024, the Federal Reserve posted a $77.5 billion loss—an improvement over the $114.6 billion loss in 2023. This marked the second consecutive year in the red, but the rate of losses is slowing.

The Fed last turned a profit in 2022. If rate cuts proceed as expected, the central bank could reach profitability in 2025.

Interest Rates and Fed Profits Linked

The Federal Reserve earns income mostly from U.S. Treasury and mortgage-backed securities. However, when it raises rates, it must pay more interest to banks and money markets to maintain rate targets.

In 2022 and 2023, rising rates caused these payouts to balloon, exceeding the Fed’s income from securities. This inverted the profit model, producing unprecedented losses.

Returning Funds to the U.S. Treasury

Typically, the Federal Reserve returns its surplus income to the U.S. Treasury, helping to reduce federal deficits. That hasn’t happened for two years.

However, Morgan Stanley’s outlook is optimistic. Rate cuts and bond income adjustments could accelerate the Fed’s return to profitability.

Once that happens, the Fed could begin replenishing its deferred asset balance before resuming payments to the Treasury.

Fed Says Losses Don’t Affect Policy Tools

Fed officials have repeatedly stated that operational losses do not compromise the bank’s ability to conduct monetary policy.

The Federal Reserve can still manage short-term interest rates, inject or withdraw liquidity, and fulfill its dual mandate of stable prices and maximum employment.

“This is primarily an accounting issue,” a Fed spokesperson previously said. “It doesn’t impact our tools or independence.”

Path Forward: Smaller Balance Sheet and Rate Cuts

Going forward, the Federal Reserve is expected to continue reducing its balance sheet. At the same time, if inflation continues easing, the central bank could cut rates multiple times in 2025.

Both of these moves would reduce the Fed’s liabilities and increase the likelihood of a return to positive earnings.

Analysts believe that with continued improvement, the Fed may again become a profit engine for the U.S. government.