QE, QT, & Liquidity Prepared for Global Interdependence Center Whalen Global Advisors LLC 348 W 57th Street, Suite 342 New York, NY 10019 Š Whalen Global Advisors LLC (2019)

QE, QT, & Liquidity • Since Q4 2018, the FOMC has faced a deteriorating market situation when it comes to liquidity, this as debt issuance by the US Treasury has risen significantly and once plentiful excess reserves were drained from the system via “quantitative tightening” or QT • The FOMC has now reversed its 2018 policy goals, ending increases in the target for FF and ceasing shrinkage of the Fed’s balance sheet – and indirectly bank deposits. Domestic bank deposits in the US have not grown significantly in the past year and in some cases have declined • The FOMC has dropped the FF target and is now adding reserves back into the system in a short-term version of “quantitative easing” or QE. The short-term repo operations announced by the FOMC likely will be made permanent a la TALF and other post crisis liquidity facilities 10/9/2019

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Source: FDIC

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Bank Liquidity & Prudential Rules • In addition to the impact of monetary policy, market liquidity has also been obstructed by the migration of banks back into Treasury and agency collateral as zero-risk excess reserves have become more scarce. Excess reserves do not require a hedge, but available for sale securities do. • In addition, prudential regulations regarding liquidity and market risk have impacted the market behavior of large depositories, causing banks such as JPM, WFC and their peers to withhold liquidity from customers, particularly at quarter end. Volatility levels are significantly above historical levels • Well-intended prudential and monetary policy goals are in conflict, with G-SIBs withholding liquidity from smaller banks and non-bank financial intermediaries, causing a divergence or “tiering” between the cost of funds for larger banks and GSEs facing the Fed and everyone else in excess of 30bp or more

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6

DTCC GCF Repo Index® Historical Data January 2005 through 2018

5

4 MBS GCF Repo® Weighted Average Rate

Treasury GCF Repo® Weighted Average Rate

3 Weighted Average Rate

Agency GCF Repo® Weighted Average Rate

2

1

0 1/3/2005

1/3/2006

1/3/2007

1/3/2008

1/3/2009

1/3/2010

1/3/2011

1/3/2012

1/3/2013

1/3/2014

1/3/2015

1/3/2016

1/3/2017

1/3/2018

Year -1

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3

DTCC GCF Repo Index® Historical Data 2018

2.5

2 MBS GCF Repo® Weighted Average Rate

Weighted Average 1.5 Rate

Treasury GCF Repo® Weighted Average Rate

1

0.5

0 1/2/2018

2/2/2018 3/2/2018

4/2/2018

5/2/2018

6/2/2018

7/2/2018

8/2/2018

9/2/2018 10/2/2018 11/2/2018 12/2/2018

2018

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Source: DTCC

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Conclusions • Looking at the data, it seems pretty clear that the markets have experienced growing liquidity stress going back to Q4 2018. Despite their celebrated data dependence, FOMC members & Fed staff seem to have missed these clear warning signs • Going forward, given the strength of the dollar and idiosyncratic factors related to Basel III/IV, bank liquidity rules and market risk, we anticipate that the G-SIBs will be net takers of funds going into year end, raising the question as to whether the FOMC will step up to meet the demand for liquidity 10/9/2019

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Contact Information Christopher Whalen Whalen Global Advisors LLC o: 1-212-644-8969 e: chris@rcwhalen.com

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