The Fed's D-Rate: 4.5% At Dec 31, 2013... And Dropping Fast

Tyler Durden's picture

In April of 2010, Zero Hedge first brought up the topic of the Fed's DV01, or the implicit duration risk borne by the Fed's burgeoning balance sheet which at last check will approach 25% of US GDP by the end of 2013 (tangentially, back in 2010 the Fed's DV01 was $1 billion - it is nearly $3 billion now and rising fast). Recently, we have noticed that the mainstream media has, with its usual 2 year delay, picked up on just this topic of the implicit and explicit risk borne by Bernanke's grand (and final) monetary experiment. And slowly but surely they are coming to the inevitable conclusion (which our readers knew two years ago), that the Fed has no way out? Why? Ray Stone of Stone McCarthy explains so simply, a Nobel prize winning economist can get it.

From Stone McCarthy

Further asset purchases would compromise the Fed's longer run profitability in two ways.

 

First, because the securities have been purchased during a period of economic distress the yields on these securities are unusually low. The purchase of these securities has been financed by reserve creation. The cost of reserve creation is the interest rate paid on reserves (IOER) currently only 25 bps.

 

Of course, the interest rates on IOER, RRPs, and Term Deposits all represent variable interest rates, while the yields on SOMA are effectively all fixed rates. Thus, there is an asset/liability mismatch, which could compromise the Fed's Net  Interest Income (NIM) should short term interest rates rise. The Fed's exit from the extraordinarily low funds rate regime will not be compromise by the prospect of reduced or negative NIM. Instead, the remittances to the Treasury would be reduced or suspended.

 

How high do these short-term interest rates have to go before the NIM become negative?

 

In 2012 the Fed generated $80.5 bln in interest income on an average $2.606 bln in SOMA holdings, or about 3.1%. The SOMA was funded by paying only 0.25% on average reserve balances of $1.527 trillion or about $3.8 bln. In other words NIM was about $77 bln.

 

Had the IOER been consistent with what FOMC participants regard as normal in the longer-run, say 4-1/4%, NIM in 2012 would have been only about $15 bln, with a slightly restrictive posture, say 5-1/4% NIM would be close to zero, and with at 5-1/2% NIM would have been negative.

 

Now if we do the same arithmetic with a SOMA that is increased by $1 trillion due to the asset purchase programs, even keeping the effective yield at 3.1%, we see that NIM turns negative at a lower funds rate. Gross interest income from SOMA would increase to around $115 bln. At the same time if the IOER was set at 4-1/4%, NIM would fall from $15 bln to only $4 bln. At a 4-1/2% NIM becomes negative.

In other words, at Dec. 31, 2013, a 4.5% interest rate (or, as we call it, the D-Rate) is where the Fed starts losing money.

And then, if the Fed waits another year, the NIM breakeven is 3.5%... if the Fed then waits another year, the NIM breakeven drops to a minuscule 2.5%... and so on until year after year, the tiniest rise in rates will force the Fed approach Congress and explain why suddenly, not only is it not remitting interest income to the Treasury, but why just as suddenly, there is now a credit balance, that has to be funded by the Treasury (a move which monetarily will require the Fed to bail itself out, but which politically and economically will be an epic and final hit to the credibility of the Fed, as the Fed will be officially printing money just to print money).

Of course, the above analysis assumes the Fed delays and avoids exiting QE in 2013, and then 2014 (and so on) as this is the last instrument Bernanke and his successor have to push up the stock market, never mind the economy, the unemployment rate or inflation. Which the Fed will have no choice but do, and yet the longer it build the wall of QE worry, the greater the negative sensitivity to even the smallest increase in interest (and IOER) rates, if and when inflation picks up and Bernanke is taken to task with his "15 minutes" promise of eliminating hyperinflation.

In other words, while QE4EVA may be unlimited in the eye of the beholding Chairman, it is very much limited by the amount of reserves pumped into the system, and the amount of cash that Ben will have to pay banks as interest on their excess reserves.

Finally, as once again Zero Hedge readers know well ahead of everyone, it will be the foreign banks that will be the proud recipients of the tens or hundreds of billions of IOER funds when the inevitable IOER rate hike starts. This was explained here:

[S]ince it is improbable that excess reserves held by any banks will decline at all in the coming years, one can also assume that the annualized interest paid to foreign banks, which would amount to at least $5 billion pear year, every year, will continue indefinitely as a direct Fed subsidy to the bottom line of Foreign banks.

 

All of this, of course, ignores what happens should the Fed hike interest rates across the board, which will also mean rising the rates on IOER, once inflation finally strikes: simple math means a 1% IOER means some $20 billion in interest paid to foreign banks, 2% - $40 billion, 5% - $100 billion paid to foreign banks, and so on. Putting these numbers in perspective, let's recall that Italy's third largest bank just got a €3.9 billion bailout (its third), and has a market cap of some €2.9 billion.

Expect the MSM to figure out that it is precisely the foreign banks operating in the US, which now hold well more than half of all excess reserves in circulation, that will be the majority benefactors of the dollar bonanza that will be unleashed once the IOER begins its trickle up, in the next few years (or months at the rate record gasoline prices are soaring). Sadly, by then will we have far greater problems as a result of nobody once again understanding what is really going on behind the scenes.

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valkir's picture

Dunno for you,but i can not wait untill december 2013.

Big Slick's picture

"... which monetarily will require the Fed to bail itself out, but which politically and economically will be an epic and final hit to the credibility of the Fed, as the Fed will be officially printing money just to print money"

Gold: the arb of the millenium

Big Slick's picture

Another great blast from Tyler’s’ss’s past:

 

Doubling Down To (DXY) Zero: Has The Fed, In Its Stealthy Synthetic Bet To Keep Long-Term Yields Low, Become The Next AIG?  (ZH: 4/16/11)

 

http://www.zerohedge.com/article/did-fed-its-stealthy-synthetic-bet-keep...

"Stunningly, today we learn that to keep long rates low, the Fed may have resorted to nothing short of the same suicidal trade that destroyed AIG FP and brought the entire system to its knees. Namely, Ben Bernanke is now quite possibly the second coming of Joe Cassano, since in order to keep rates low, Bernanke is forced to a last resort action of selling billions upon billions of Treasury puts to "pin" rates low contrary to natural supply-demand mechanics."

"it appears that far from being worried about hedging its SOMA book synthetically, the Fed may well have be constantly doubling down on its risk exposure in the form of off-book derivative contracts in order to "pin" Long-Term rates (read the 10 Year) by constantly selling Puts on Long Dated Treasurys at opportune times when there is no incremental buying of the underlying security, yet when, as the CDO and upcoming ETF debacles have so well demonstrated, the price of the derivative actually impacts the price of the underlying!"

 

THERE IS NO DOUBT IN MY MIND THAT HUNDREDS OF YEARS FROM NOW, WEB ARCHEOLOGISTS WILL BE STUDYING ZEROHEDGE ARCHIVES FOR THE ANSWERS TO WHAT REALLY HAPPENED!

 

Big Slick's picture

(sorry for the earlier CAPS and bold.  I'm okay now)

DJ Happy Ending's picture

Excess reserves are for housewives and little girls.

GetZeeGold's picture

 

 

a Nobel prize winning economist can get it

 

Timmy, don't stare at the Nobel Prize economist freak....it's not polite and it's bad manners.

 

Above all, never stare at a Nobel Peace Prize winner....it's a good way to get your ass drone striked.

economics9698's picture

He's really, really optimistic.  The Fed will be bankrupt after around 50 basis point hike in the 10 year.  After that they print to cover operating expenses and to pay off Rothschild and Goldman.

TruthInSunshine's picture

I'm waiting in anticipation to discover what new scheme Bernanke & Crew have cooked up to keep the dinner table from "wobbling" (let alone crashing down).

I can envision a pamphlet somewhere in the bowels of 33 Liberty Street titled something like New Thought Experimentation Using Mutant & Hybrid Strain MMT to Further Delay The Widespread Comprehension & Public Recognition of Critical, Adverse Economic Effects, by Charley Ponzi (Red Shield Publishing).

Big Slick's picture

In a great Paul Brodsky podcast on Chris Martenson's site last year, he estimates only a 40-50 bp rise to make the Fed's balance sheet insolvent.  Screw waiting for the government.. the people's markets with take us back to a gold standard.  It WILL happen, one way or another.

I envsion a sudden revealing of the "New USD" being exchangable for gold (and old dollars at some ratio)

BurningFuld's picture

Down arrow because the remarks were sexest? OK, carry on.

Yes_Questions's picture

 

 

and there will be a TV show expoloring the topic who's host has Big Greek Hair.

 

+Tyler’s’ss’s 4EVA!

FL_Conservative's picture

I agree with Tyler and Stone McCarthy, but wouldn't the Fed's next play be to reduce the IOER to zero?  Wouldn't that eliminate the risk of NIM going negative?  What's the implication of this?  I would think that banks would be want to accelerate lending in that case, so they could generate earnings from those reserves, and that would fuel the rampant inflation we've all been expecting.

gorillaonyourback's picture

Its the new risk free rate of return not the treasury market
If they lower to zero how do you charge depositors to keep their money in the bank :they want people to spend and USE the banking system. That's why the best way to collapse system is to pull ur money out of system

gorillaonyourback's picture

Its the new risk free rate of return not the treasury market If they lower to zero how do you charge depositors to keep their money in the bank :they want people to spend and USE the banking system. That's why the best way to collapse system is to pull ur money out of system

walküre's picture

the Fed will be officially printing money just to print money"

currently the Fed is printing money just to print money INOFFICIALLY?

that bag for the cat must be huge. someone give that cat a map to find its way out.

*******

ZH is part of future historical archives .. 100% agreed. The truth was out there which will give future historians hope that mankind was not all lost in this age.

CNBC, Faux News and Pravda will be lumped into examples of dangerous propaganda.

Rip van Wrinkle's picture

The victors will write history. Make sure it's you guys.

Yancey Ward's picture

Face it, these "you guys" will be in Guantanamo writing the history on the walls in feces.

MeMadMax's picture

I like that one!

"as the Fed will be officially printing money just to print money"

GreatUncle's picture

So do I.

The first realisation of a money tree has been discovered.

 

midtowng's picture

This is a valuable article. Now we have a time range for when the dollar-based money system breaks down, and its only a few years away.

If China doesn't hurry up and break away from the dollar peg, they will go down with us.

kridkrid's picture

Not sure how that would work exactly. By breaking from the peg, they bring the system down, no? This thing can't be avoided any more now than it could in the 1930's. Global depression, war, financial system restart. Only this time, the world has a bit of a resource problem and a lot more people.

NotApplicable's picture

I think you mean a time range for the "outbreak" of war.

Banksters will continue to " muddle-through" while blaming everyone else.

Stock Tips Investment's picture

The figures are very clear. Now we know what the (first) limits the Fed.

SilverDoctors's picture

Dont see this on ZH yet Tyler- the Treasury Dept has released the results of its audit of US gold held at the NY Fed..unfortunately for the cartel Turbo Timmy must have helped write the report, because the Treasury department just inadvertantly admitted that the US has a whopping total of 466 tons of gold stored at the NY Fed!

http://www.silverdoctors.com/treasury-dept-releases-findings-of-ny-fed-g...

Captain Benny's picture

+1 because you sell me bullion at great prices.  Thanks for your hard work SD!

new game's picture

if this true, wtf can we believe anymore, this will add one hellava big buyer in the open market.

NY fed, China, India, Ruskies, ZHers-that rounds out the big 5 buyers...

somtin says buy the fuck out of this dip...

BTFDemocracy's picture

Scroll down to see $4 trillion in cash in front of the Federal Reserve building:

http://demonocracy.info/infographics/usa/federal_reserve-qe3/money_print...

 

Desert Rat's picture

wow... +1... thanks.. but even with the visuals, it is still not something that is easly put into context of everyday life...

TruthInSunshine's picture

Was the gold holding expansion reported pre or post ZH's article on 60 Victoria Embankment in London?

Central Wanker's picture

This is utter bullshit. The majority of US Treasury gold is NOT stored by Fed. It is stored by US Mint in Denver, Ft Knox and West Point. 

http://www.fms.treas.gov/gold/current.html

ATM's picture

+1

Saved me the time to look it up.

Hard Assets's picture

Now don't get your panties in a bunch ladies !

466 tonnes (physical) + 7667 tonnes ("deep storage") = 8,133 tonnes

The audit and accounting are bang-on, there is NO problem !

Right-on Left-off's picture

Sounds to me like Ben has created a Frankenstein which is actually a self destruct doomsday machine with the added attraction of ... guess which scenario and time line will hit the final destruct button or will it just blow itself up and us too.

Poof, All Gone!!!   No more FED, no more FED Notes, no more US Bonds or Notes, no more US Treasury ....  You can take it from there.

 

kentmills's picture

Actually, the IMF will take it from there.  Queue exit from America, for smart ZHers.

OddFieldIsStrong's picture

"And then, if the Fed waits another year, the NIM breakeven is 3.5%... if the Fed then waits another year, the NIM breakeven drops to a minuscule 2.5%... and so on until year after year,"

I am a bit slow admittedly. Could someone please help me out and explain why the NIM breakeven drops 1% per year? Thanks.

socalbeach's picture

I don't know either, Tyler's calculation is probably off.

It looks like Stone McCarthy (SM) is assuming excess reserves increase the same amt as the Fed's SOMA holdings (figures below in billions).

So if SOMA goes from 2,606 to 3,606 then excess reserves go from 1,527 to 2,527. And if the interest rate the Fed receives stays the same at 3.1%, the Fed earns income of 112 (0.031*3,606) vs payments of 107.4 (0.0425*2,527), or a profit of 4.4 which matches SM's NIM of $4 billion in the article.  And a 4.5% IOER would set NIM to -1.9 (3,606*0.031 - 2,527*0.045) which matches their statement that NIM becomes negative at 4.5%.

So if Y is the number of years that both SOMA and excess reserves increase by 1 trillion (1,000 billion), the Fed loses money when,

SOMA income < IOER payments or

0.031 * (2,606+1000*Y) < IROER/100 * (1,527+1000*Y) or

interest rate on excess reserves = IROER > 100*(80.786 + 31*Y) / (1,527 + 1,000*Y).

So after 2 years (Y=2) the IROER breakeven is 4.04% not 3.5%, after 3 years (Y=3) the IROER breakeven is 3.8% not 2.5%, etc. Per formula, lowest IROER breakeven ever would be 3.1%

OddFieldIsStrong's picture

Thank you for the very clear explanation ;-)

francis_sawyer's picture

NIM-rods...

~~~

The good news is, OTOH, now we know where JPM stashes its gold...

SomebodySpecial's picture

Does this mean somebody has a drop dead for this mess? Oh thank goodness!

fuu's picture

"it is precisely the foreign banks operating in the US, which now hold well more than half of all excess reserves in circulation, that will be the majority benefactors of the dollar bonanza that will be unleashed once the IOER begins its trickle up, just a little over two years from now."

 

Bankster SNAP.

francis_sawyer's picture

I'll bring the marshmallows if you bring the graham crackers & chocolate...

shutdown's picture

Doesn't he mean 3 trillion?

Big Slick's picture

What's 3 orders of magnitude between friends?

Big Slick's picture

But seriously, $3 billion is the dollar value (or change in the bond's value) per basis point change in yield.

lolmao500's picture

Yeah like it'S gonna go to 4.5%... please. Bondzilla will be a myth for quite a few more years.

resurger's picture

In Bizaro world that we live in , when inflation rate goes up, interest rates goes down ... Japan comes to mind..

At this point, we can now see that the DV01 is now matching teh fed's balance sheet 3T= DVO1= 3bn, just remove three zeros ...

have we reached the flat pancake scenario where the long end is matching the short end which equals zero or flatline..

PS: HE WILL NEVER EVER RAISE INTEREST RATES IN 15Minutes, it will never happen.

Print Motherfucker

francis_sawyer's picture

The BERNANK is 'JOOdini' bitch... He can do it in 5 MINUTES if he wants...

~~~

http://www.youtube.com/watch?v=d_TxhaYYJmQ