Many view the recent decision of Federal Reserve head Janet Yellen to increase the interest rates for the first time in nearly a decade to be a sign that the economy has fully returned to normal following the great recession of 2008. However, there is a major unintended consequence of this action that will cost the Fed billions and greatly benefit foreign banks who hold reserves at the Fed.
The move has doubled the interest rates on excess reserves (IOER) from 0.25% to 0.5%. As a result, foreign banks are now set to collect interest from the Fed at twice the previous rate. Over the next 12 months, assuming all remains equal, foreign banks will pocket $6 billion from the fed, bringing the total amount of cumulative Fed cash payments to $21 billion.
However, this is a very low estimate because Yellen is certainly planning to conduct more interest rate hikes in 2016. In fact, key sources have indicated that there will be at least four additional interest rate increases next year, probably around the months of March, June, September and December. This will further increase the IOER to 1.5% by the end of next year.
Because of this, foreign banks operating on United States territory will receive a whopping $11 billion in IOER interest. This will bring the total amount of cumulative interest received from the Fed to $26 billion. The United States is basically handing out a riskless profit to foreign banks, all of which is subsidized by the Federal Reserve.
With no plan to reduce the Fed’s massive balance sheet, this cycle looks like it could continue indefinitely. So in raising the country’s interest rates, the fed is generating massive profits for foreign banks, most notably ones in Europe. And with manufacturing in the United States showing signs of slowing down, this move is potentially coming at a very troublesome time. It’s very fair to question the motives of Janet Yellen and the Federal Reserve here.