The Risk Profile of the Federal Reserve's System Open Market Account Holdings of Domestic Treasury Securities and its Implications for United States Taxpayers

Abstract: The composition of the System Open Market Account Holdings of Domestic Treasury Securities, along with its financial risks, may have implications for the funds transferred to the U.S. Treasury, potentially leading to higher taxes for American citizens. Estimating the market price and duration of the Federal Reserve's Treasury holdings, we find that the portfolio's exposure to interest rate risk amplifies unrealized losses under a stressed scenario. Furthermore, the interest earned and paid on the market value of Treasury holdings have a direct impact on the Fed's net income, particularly in an environment with increasing interest rates. This relationship implies that if the Fed incurs losses, the federal budget may need to further rely on American taxpayers. Our thesis highlights the dynamics between the composition of the Federal Reserve's Treasury portfolio, its exposure to financial risks, and the broader financial implications for the Federal Reserve, the U.S. Treasury, and the American taxpayers, contingent on the Treasury portfolios unrealized and realized losses.