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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Big Slick's picture

Seriously, WHY does it always have to go there?

Yen Cross's picture

 I'm 1/2 joo. I think? Francis is a brilliant mind. Get over the stigmas and learn.

francis_sawyer's picture

@Big Slick


I often ask myself the same question...

But seriously ~ If Bernanke doesn't want himself involved with 'ad hoc' comparisons with 'Whodini'... He should refrain making idiot comments like he can fix things in '15 MINUTES'... Hell ~ he could have also stayed away from the profession of central bankin & stealing everybody's money, whereby I'd totally leave him alone...


SheepDog-One's picture

I'm convinced they're just marching in place until whatever 'event' decided on at the last Bilderberg meeting that takes it all down again is pulled off.

francis_sawyer's picture



I get the impression that they're fighting against themselves at the moment... [JMHO]... I'd heard rumors that 'Mittrens' was smuggled into last years Bilderberg [which often portends WHO their guy is]... The fact that there were opposing forces enough to NOT make that happen suggest to me that there are competing agendas at the moment & a power struggle is going on...

tango's picture

Corrrect.  It is unlikely that the FED will raise interest rates until absolutely forced.  Then, the only way it can possibly be plausible is for the FED to monetize the interest.  Thus, we are monetizing the monetizing of debt - markets soar!  LOL

resurger's picture

The Fed is facing serious duration risk, if they spike the short term interst rates to curb inflation (which will be a huge spike in short term interest rates) then that means the TBTF and thier minions who are involved in carry trades / Equity leverage will have their heads handed to them, and you wil see the great rotation from Equity to AAA safety (And the sheeple will be teh victims ofc). But not just that, the long term Fed US Treasury holdings is really huge, the duration risk will not be offseted by buying the short term paper, and then you will also have a scenario of an inverted yield curve, so if they let short term goes to 5% can the long term be 10% ... in case if the 5-10% happens that means the Fed has to double down really big and start buying lots of paper to lower its duration which means:

Moar & Moar QE and more Twist .. the MATH just doesnt add up.

long story shrot , you are 100% right, they will monetize everything and when they monetize interest payments it will be the end.

PS Gold is trading at discount relative to the Fed's balancesheet.

socalbeach's picture

If gold stays at its current price, it's going to get to about year 2000 levels vs the Fed balance sheet by the end of the year (assuming monetization continues at $85 b / month).


monetary base (Fed balance sheet) vs gold

chdwlch1's picture

Thanks for your view of how this will play out...seems very likely.  However, I would like to add a 'twist'.  Instead of "if the 5-10% happens that means the Fed has to double down really big and start buying lots of paper to lower its duration...", I believe the US citizens will once again be called on to buy the needed Treasury notes.  Maybe this is when the inevitable requirement that 401k plans purchase X% of Treasury paper will take effect and significantly reduce the Fed's buying requirements.  Of course, this is all for our own protection....

Lord Of Finance's picture

Coming soon to a book store near you:


   'Lords of Finance II'- (The Bankers Who Broke the World-----AGAIN!)

thomasincincy's picture

D = Dick yeah..what ever

yogibear's picture

LOL, Bernanke and the Fed will print until it has a full blown currency crisis.

Everyone in the world  rushes to escape US dollars or toilet paper.

Krugman and the rest of Keynesian zombies explain how you get out a currency crisis once it's triggered?

Bernanke and the Fed are digging a huge hole in the bottom of the ship, once through the USS USA sinks!




Notarocketscientist's picture

Krugman is a one trick pony.   Stimulus stimulus stimulus.... as if that could go on forever.

philosophers bone's picture

I don't see many "outs" for the Fed.  Won't they need to wind it down quickly after they stop QE?  One way out for them would be have an equity crash which then sends interest rates deep into negative territory, driving up the price of the current bonds held by the Fed.  Then, the Fed packages up all of the bonds and sells them at a profit to the people (or pension funds / governments) at the inflated price.  If we do not voluntarily purchase, the gov't may force us.  What other "outs" are there for the Fed?

youngman's picture

Why would a pension fund want to buy a .00025% return bond when it needs 8% to me the pension funds will all be invested in Uganda Uncle BoBo´s bonds paying 6%...

If interest rates go up....the USA is in Default territory

so I see the only option is to buy until the currency fails..hyperinflation..the dumping by the rest of the world...when the Feds balance sheet hits 30 trillion..or more then its over..but then again at that point they will never tell us what their balance sheet do not need to know..but you will see a lot of private jets at maximum gross weight flying to some island.....and it won´t be pieces of paper they will be carrying

Dr. Engali's picture

Two things wrong with your scenario. The first is the fact that the Bernank is holding a bunch of crap paper that nobody wanted in the first place.... That's why he has it. The second problem is if the system crashes again bonds crash with it as everybody is scrambling for liquidity. Look at the extraordinary measures they had to take just to keep money markets from crashing last time around. There is no way out for the fed on this one.

Notarocketscientist's picture

Gold.  Time to stock up at 1600 bucks an ounce.

Big Slick's picture

Beautiful thing is that the bastards responsible for DV01=$3 billion are the same bastards holding Gold to $1600 an ounce as I transition out of toilet pa.. errr.. Federal Reserve notes.

Haus-Targaryen's picture

Other than cutting spending and running surpluses what can be done at this point?

Venerability's picture

I'm just placing this here because it's the latest story:

Xinhua has no fewer than 4 top stories overnight on how the weak Yen threatens China.

China is already so hostile to Japan, there've been anti-Japan riots and demonstrations for months now.

G-20 namby pamby statements or no, the Chinese will not take the weak Yen threat lying down.

youngman's picture

I think South Korea is more worried about the weak Yen than China...


Yen Cross's picture

Respect Women, My Mother raised 3 kids, and did a good job of it!

Just Ice's picture

Yen looks overdue for an upside correction...looking at the absolute freefall it's been in on weekly chart, could see a big/sharp bounce...the whole 1997 Asian currency crisis was precipitated by China trashing the value of its currency so no sympathy there...karma.

q99x2's picture

Damn. I should have taken the blue pill before I read this article.

Totentänzerlied's picture

"Fed's longer run profitability"

That's just a Krazy Konspiracy Theory.

Captain Benny's picture

I'm still on acronym overload...

This article is booked for re-reading tomorrow after I think more on it.  Like was said above, maybe the blue pill was appropriate :)

paperlessforms's picture

Great article. Thanks. Thought provoking in the extreme.

At the outset of QE Gordon Brown said that it works if 'everybody does it' That means all National Banks. Which I believe is still happening witness 1 trillion to Europe last week.

So Bernanke should get owed money *from* foreign banks as well as owing money *to* foreign banks. It should balance out.

This then makes it necessary to tie interest rates of all the banks together, otherwise unfair imbanaces occur (as you point out).


ArkansasAngie's picture

Got it covered? Labor? What could go wrong?

When things get serious ... you ... Errr ... they lie.

Hard Assets's picture

Absolutely !!

Recall 2008, all CB's simultaneously opened the spgots full bore !

Same shit, different catastrophe....

These CB crooks 'sell' the austerity crock to the sheeple, dumb them down, fuck 'em if they starve to death. The only game left is to inflate their way out.

All CB balance sheets have 'hockey sticked'. US debt at 16+Trillion MUST be made "smaller".

Won't be all that long before central bankers get shot on a daily basis. I have actually asked myself why it hasn't started yet, especially since '08. I am not saying that I will partake in the fun, in fact all ZH'ers will not take part as we have known the outcome for some time.

You sorta have to shrug your shoulders and ask them, "WTF do you think would happen?"

q99x2's picture

Look how lucky we've been. No need to worry about a little DV01. I almost lost my lawn and garden service back in 1983 and didn't even know it.

I'm very thankful I'm not dead yet. But it doesn't look promising.

The international reward has found retired Soviet officer Stanislav Petrov, who averted a nuclear war in 1983 by telling his superiors not to press the red button.

It later proved to be a technical failure of Soviet satellites that interpreted sunlight reflected from clouds as rockets fired from a US base.

Yen Cross's picture

PIMCO will front run anything. Bill Gross (human algo)0>

Flesh Wound's picture

Balancing... Something the Fed does extremely badly.

socalbeach's picture

Why would the Fed have to increase IOER if interest rates start rising?  Keep in mind the following quote from page 45 of a paper (*) that was linked here recently:

"Some commentators have worried that if price inflation takes hold and market interest rates rise, the Fed would have to offer increasingly higher rates of return to stay competitive. Since the interest is paid with newly created money, which adds to the reserves, this by itself increases the money supply. The concern is that as the money supply grows, interest rates have to increase further, and the Fed could be boxed into a corner, where rising interest rates and additions to reserves chase each other upwards in a reinforcing spiral.

However, what these authors overlook is that the Federal Reserve can always reduce the level of bank reserves, at any time of its choosing, through the sale of its assets. What if it ran out of assets to sell? This is unlikely. Any institution that is permitted to create money out of thin air, can, in conjunction with the government, create assets. The government simply issues new treasury bonds, which it then “sells” to the Federal Reserve. The Fed “pays” for them with newly created money, but the money does not enter circulation; rather it is held dormant in a special account. Meanwhile, the treasury bonds can be sold by the Fed to the public through its open market operations. In September 2008, at the Fed’s request, the Treasury created the Supplementary Financing Account, specifically for this purpose. Provided the public is willing to buy the bonds, the Fed has the ability to reduce the level of bank reserves, and hence constrain the issuance of fiduciary media..."



new game's picture

what if the open market says nien? fed buys there own shit?

see what is missing in this discussion is the aspect of faith-when that evaporates by chinas lust to take down this weak link called the dollar - it fucking will.

we did it to england and they will do it to us-treas dump 101.

folks this is not that difficult...

Yen Cross's picture

nein nein nein.  German GDP...

new game's picture

simply put china is sitting at this card game and being delt a shitty hand as jpy buys 500b with junk money.

they can turn the table over, as they accum gold...

g20 card game is got some players that don't like the house(fed), and have options...russia(iran) ex. ect.

fucking digital money games, but ignores real assets;oil, sustainable farmland, water and sheer numbers of population affected.

these dynamics will determine where this goes. the military tries to enforce this regime, but these players have toys too.

and they are fed up(pun intended) with being told where to shit - econ hit man stuff.

this will become boodshed and then these digital money games will be on the back burner and winner takes reserve status and game starts all over with world chaos first...

wild cards: n korea, iran, and syria(by proxy russia) and s korea and brazil to lessor extent...


new game's picture

left out euro, but, simpler yet is to look at underlying econmies supporting the pyramids of junk money.

still comes back to faith in these fuckers playing their digital money games.

I FUCKING BELIEVE the cracks are starting, as cog dis says, the crumble is ongoing

til da crumble leads to war-the pacific-far east? mid east? black swan attack of usa?

europe again? most don't want it, but it is unstoppable as history repeats.

gamers game and game get heated, and out comes da guns...

fucking cheats at the table

wild bill h. style...

call the sheriff.

haha-he is fucking mary lou.

Yen Cross's picture

 I like you.  You lay the wood , and don't take prisoners!

BandGap's picture

What if the government, in their infinite wisdom, demands IRA and 401K monies to buy the bonds? There are already rumblings that no one should be "too rich" to retire while the rest of the people have to keep on keeping on. The spiel would be something along the lines of the goivernment managing EVERYONE's retirement, that way it is "fair". Think about it. This kind of bullshit was unthinkable before Bizarro World took g\hold, but I could see this shit happening to keep the happy bus moving right along. Hell, government pensioners would immediately buy-in since there is no way they see the returns they have been promised. Again, there are a lot of people who see nothing wrong with once again squeeziung the middle class.

Dre4dwolf's picture

Wait, since when does the Federal Reserve have to be profitable?


How are you no profitable when everything you buy is bought with money you printed in your basement?


Thats like me saying "I bought 10 houses with money I printed out of nothing", but gosh darn all the houses I bought are worth less than their purhcase price.


The houses were free to you, so you really cant say you lost money on the deal, infact you could sell the houses for 99% less than what you paid for them and you would still be UP in that situation, granted you should of just printed 1% of the houses value and handed it to yourself and save yourself the circle jerk.



Also, who the hell CARES? if the Fed is profitable or not? the Rothschilds? they fucking print money out of their basement,  they probably seriously have their own printing plates for every major world currency at this point, I hihgly doubt they even give a crap about their shares in the federal reserve or how profitable it is.... 


michael_engineer's picture

Yes this was a good post. These things just go to show that the business model is changing even at the WFed level. How can that be? What is being implied? What are the root causes?

Yen Cross's picture

 I care, and that was a good post  Dre4dwolf

Sandoz'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."

Who's lost more credibility over the last 5 years, ZH or the Fed?

As it stands, I don't think ZH is in a position to question anyone's credibility. So few have been so wrong so consistently.

And of course now they're "officially printing money." Does this mean that all those hyperventilating posts about Ben's money printer were just a farce?

socalbeach's picture

The answer to your question is that the Fed has created about $2 trillion ($3 trillion - $0.85 trillion) in reserves since the financial crisis in 2008.  The shorthand way of referring to that is "printing money", so the posts here and elsewhere talking about Fed money printing were accurate.

sodbuster's picture

What do you want to bet, the Fed's balance sheet is a helluva lot bigger than they are admitting to??

Yen Cross's picture

Stated debt to GDP is 105%. We all know that is complete bullshit.  Asia F/X looks heavy.

falak pema's picture

bankrupting the FED is the ultimate way of imposing that the current USD hegemony ends.

Maybe the oligarchy PTB want this to happen by 2017; when its time to revamp the whole US nation state concept and declare the world under NWO control. 

We are heading there...unless the Brics pull the plug on the system before that occurs.

YOu never know when rival Oligarchs can fall out; think Sarajevo 1914! 

The west definitely is heading to Corporate Oligarchy rule on its own momentum. And they can reinvent the money game, declare nation states bankrupt, destroy the incomes base of salaried slaves and pensioners anywhere/everywhere, at the stroke of a CB pen or electronic monetary button.