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Portfolio > Portfolio Construction

The $200 Billion Hit to the Fed’s Bond Portfolio (and Yours)

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The yield on 10-year U.S. Treasuries has surged some 47% year to date.

Bond investors, especially those with jumbo-sized positions, are getting hammered. How much money has the Federal Reserve lost?

At the end of July, the Federal Reserve held $1.98 trillion in U.S. Treasuries. That figure represents just over half of the Fed’s $3.6 trillion balance sheet.

“Our estimate shows that the spike in bond yields since the first quarter of this year has caused a mark-to-market loss of $192 billion on the Fed’s holding assets, equivalent to approximately all of the unrealized gains that the Fed had accumulated since it began to implement quantitative easing in late 2008,” according to Scott Minerd, global chief investment officer at Guggenheim Partners.

“Although in keeping with their own accounting principles the Fed does not record mark-to-market losses, a continued increase in bond yields would incur actual losses should the central bank decide to sell assets,” Minerd explained.

ETF Impact

Leveraged short Treasury ETFs, like the ProShares UltraShort U.S. Treasury 20+ Bond ETF (TBT) and the Direxion Shares U.S. Treasury 20+ 3x Bear Shares (TMV) have jumped between 16% to 22%% over the past six months.

That’s not bad considering the fact that the total U.S. bond market (AGG) has lost 3.94%, while long-term U.S. Treasuries have fallen an even harder 10.28%. (Year to date, the iShares Barclays TIPS Bond ETF (TIP) has dropped about 8%, while the Vanguard Total Bond Market ETF (BND) has weakened by about 4%.)

Granted, Bernanke & Co. does not value its portfolio on a mark-to-market basis. But the surge in interest rates has already erased almost $200 billion in the Federal Reserve’s capital.

But that’s not all.

If interest rates continue to head higher, the value of the Fed’s liquid assets that it could sell would decline and further undermine its capital cushion. And if the velocity of rate increases intensifies, the Fed, with only $62 billion in capital, could see its entire capital base completely wiped out.

This, of course, could have a serious domino effect. It could paralyze the Fed’s ability to defend the dollar’s purchasing power, causing Treasury prices to fall further and thereby push interest rates even higher.

Just imagine, the unimaginable; a weakened and impotent Fed.

Conventional wisdom has taught investors to “not fight the Fed.” But the past is never prologue.

Plus, if the Fed is unable to contain interest rates, the only fight advisors should take up is defending client assets from the danger of higher rates.


The ETF Advisor Pro Newsletter uses a combination of technical analysis, market sentiment, and common sense to be on the right side of the market.


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