Using the Federal Reserve’s Balance Sheet to Predict Macroeconomic Outcomes

Abstract

This study investigates whether the U.S. Federal Reserve’s balance sheet can be used to predict macroeconomic outcomes. The Federal Reserve writes its own accounting standards, and I recast portions of the Federal Reserve’s weekly balance sheet as if it more closely followed Generally Accepted Accounting Principles. Specifically, I estimate the fair value of the Federal Reserve’s U.S. Treasury notes and bonds and calculate the associated unrealized gains and losses. I demonstrate that unrealized gains (losses) on the Federal Reserve’s U.S. Treasury notes and bonds are associated with lower (higher) one-quarter ahead inflation and real gross domestic product growth. Additionally, I show that modifying proxies for macroeconomic news to incorporate the predictive value of unrealized gains and losses on the Federal Reserve’s U.S. Treasury notes and bonds helps explain equity returns around the release of macroeconomic data.