The Federal Reserve is putting its future at risk by ignoring its own likely financial results when it raises interest rates. Simply put, rising interest rates will hurt the Fed by making interest costs higher and asset values lower.
While the Fed isn’t like any other bank in America, it is still subject to the immutable rules of math and interest rate risk. If the Fed starts to earn less on its investments than it pays in interest on its deposits, it will lose money.
That is exactly what the Fed is facing when interest rates rise — that it will pay more for deposits than it earns on its investments.
Taken in isolation the Fed’s balance sheet looks more like an overleveraged hedge fund than a shining example of prudent risk management. The Fed has almost no capital to back up its big macro bet on interest rates and the shape of the yield curve. Higher interest rates or an inverted yield curve where long-term assets yield less than short-term assets will cause problems. [read full story]