What Is the Taper Tantrum?

Introduction

When the Federal Reserve (Fed) announced that it would be reducing its quantitative easing strategy in the future, the term "taper tantrum" was coined to characterize the subsequent spike in Treasury rates in 2013.

According to the Federal Reserve, the speed at which it buys Treasury bonds would be reduced in order to decrease the amount of money it was pumping into the economy. As a result of the news, bond rates shot up, prompting financial journalists to dub it a "taper tantrum".

What Exactly do We Mean by Taper Tantrum?

A rapid sell-off in global equities and bonds occurred in May 2013 when the US Federal Reserve said it would reduce its huge bond-buying program, which had been in place since the global financial crisis.

Many developing market countries that attracted significant capital inflows saw capital outflows and currency devaluation as a result of this. The episode was dubbed the "taper tantrum" because of the way it ended.

The yield on the 10-year US Treasury note has risen sharply this year as well — from 0.9% to 1.4% so far this year. Globally, and in India specifically, bond yields are rising.

The post-Covid era was characterized by high levels of government expenditure and monetary easing in the United States and other countries. Joe Biden's stimulus plan, which would cost $1.9 trillion, is the latest in a string of similar proposals.

However, inflation in commodities has been on the rise as optimism for a faster economic recovery has grown. There have also been worries about the US Federal Reserve having to reverse quantitative easing and increase interest rates sooner rather than later as a result of inflationary pressures.

Because of this, it's possible that there will be another 'tantrum.' Such worries sparked a bond market sell-off last week, driving up US Treasury rates (bond prices and yields are inversely related).

Reasons Why Stock Market Didn’t Fall During the Taper Tantrum

The stock market remained healthy for a variety of reasons. The Fed's bond-buying program was not curtailed, and by 2015, the Fed had purchased an additional $1.5 trillion in bonds. As a result of this, investors' mood has been boosted and expectations have been managed via frequent policy pronouncements. A sense of calm returned to the financial markets after investors understood there was no need for alarm.

It's essential to remember that the Federal Reserve had not yet sold any of its assets or slowed its quantitative easing program. Chair Bernanke's remarks merely alluded to the potential that the Fed could do so in the future. During that period, when there was even a remote chance that Fed stimulus might be reduced, the bond market went into meltdown.

What is the Significance of Taper Tantrum?

An exodus of capital from developing market economies began in May 2013 as US Treasury rates spiked significantly for the final time. Both equity and bond investments were sold off by foreign institutional investors in India. Between May 22 and August 30 of 2013, the rupee lost almost 15% of its value. Because of this, interest rates were abruptly raised by the Reserve Bank of India (RBI) in order to stop capital flight.

Rising treasury rates decrease investor motivation to put money into riskier assets such as stocks. Equities valuations are at all-time highs particularly in the tech sector; thus, the rise in yields seemed to have given equity investors one more push in the direction of realizing their gains.

The Sensex and the Nifty dropped almost 3.8% on Friday as foreign institutional investors (FIIs) sold their positions in line with the global stock market decline. The yield difference between US Treasury bonds and those of other nations narrows as US Treasury rates rise, making the latter less appealing.

G-sec (Indian government bond) rates have recently risen as well. The glut of government bonds without a corresponding demand for them has driven up G-sec rates due to the government's large borrowing forecast for 2021-22. Concerns about inflation and the likelihood that the RBI would take appropriate policy measures (such as a rate increase) are fueling the anxiety.

Why Should you Care?

The stock market's reaction to the 2013 taper tantrum was very mild. Due to the current market valuation, investors are concerned that a yield rise may set off a longer-term market downturn. Stocks don't provide an attractive enough return now, with bond rates rising, to warrant investing in all of them. Ex-investors should be prepared for a decline in share prices; newcomers should seize the chance.

Increasing bond yields, on the other hand, maybe beneficial to investors in short-term savings plans and GOI Floating Rate Bonds, whose rates are tied to government bond yields and are regularly adjusted. Investors in debt mutual funds (particularly long-term ones) and listed bonds, on the other hand, may have to prepare for greater mark-to-market losses if rates continue to tighten.