Taper Tantrum

Taper Tantrum refers to the response to 2013 speech of American economist Ben Bernanke. He hinted that there might be a strengthening of financial regulations, hence in response traders abandoned financial assets in developing nations en masse. Instead, they shifted their capital into safe investments in mature economies.

In 2013, as the globe was beginning to emerge from a global financial crisis, the Federal Reserve of the United States announced that it planned to progressively decrease the amount of quantitative easing implemented after the Lehman Brothers collapse in 2008. This results in a slowdown in the purchase of government bonds, resulting in a reduction in the sum of funds getting pushed into the nation's economy.

• Tapering is a plan that may be defined as a strategy to 'scale back' or 'taper' the Quantitative Easing (Q.E.) or stop systematically putting funds into the economy and the institutions.
• An investor's reaction to the unanticipated update that the Federal Reserve is decreasing its asset purchases is a "taper tantrum."
• The first use of the phrase was in 2013 when traders responded to a statement from the Federal Reserve that the central bank would reduce the number of bonds it bought.
• Bond rates will rise in response to a taper tantrum because traders will sell bonds in expectation of the federal bank's tapering policy.

Before this, between 2008 and 2013, the Central bank had almost tripled the value of its income statement from around $1 to $3 trillion by buying nearly $2 trillion worth of Treasury bonds and other capital instruments to ramp up the market. This brought the total size of the Fed's balance sheet to around $3 trillion. As a result, investors had grown to rely heavily on the continued huge support for asset values provided by the Fed's ongoing purchases, and it had become a pillar of their investment strategy.

After a hiatus of more than seven years, the term "taper tantrum" has made a triumphant return to the economic language of the general public. According to the article in the Financial Times, hyperinflation and the taper tantrum have taken over COVID-19 as the primary concern for international markets.

The market frenzy had a disruptive influence on markets worldwide, not just those in the United States. It was most obvious in developing economies, which went through dramatic reversals of direct investment, which led to significant currency devaluation.

In addition, the "fragile five" emerging nations — South Africa, Brazil, India, Indonesia, and Turkey – experienced the most consequences of the turmoil. Such nations were susceptible to unexpected halts in foreign capital inflows because they had large deficits and a substantial dependency on foreign capital inflows. Moreover, these countries were also heavily dependent on external capital inflows.

Ben Bernanke, who was serving as Chairman of the Federal Reserve at the time, made a presentation before the Joint Economic Committee of the United States Congress on May 22, 2013, where he discussed the possibility of reducing the size of the bond-buying program (QE3) that was initiated as a reaction to the worldwide financial crisis that occurred in 2008.

Because of traders' interpretation of Bernanke's comments as signaling an imminent end to the Federal Reserve's extremely accommodating monetary policy, his remark sparked one of the most chaotic moments in the history of the international financial markets.

Investors began to freak out, which caused bond rates to skyrocket and share prices to fall. Despite subsequent efforts by Bernanke and Powell to convince depositors that increases in interest rates were still a long way off and shouldn't be linked with the process of tapering, the talk of tapering prompted investors to sell riskier assets in the U.S. markets to purchase bonds, which are considered to be safer investments.

Before 2013, fragile five nations were beneficiaries of significant capital inflows due to hyper-monetary policy implementation by the U.S. Federal Reserve. The international investors took out low-interest loans in the United States to finance their investments in higher-yielding resources in India, Indonesia, South Africa, and other emerging markets and developing economies.

Since the beginning of 2013, the FRED graph below depicts the daily yield on 10-year U.S. Treasury bonds.

The market faced a negative shock on May 22, 2013, when the Chair of the Federal Reserve declared that the Fed would start reducing bond buying at a certain future period. This caused bond investors to begin selling their bonds, putting the market in a downward spiral. It is highlighted in the graph by a dotted vertical line. Consequently, the yield on 10-year U.S. Treasury bonds increased to over 3% in December 2013, up from approximately 2% in May 2013. Taper Tantrum refers to this sudden increase in output.

Late in July 2021, officials from the Federal Reserve indicated that the central bank would begin to decrease the sum of its bond purchases subsequently. Due to this indication, several traders were concerned about the possibility of a second taper crisis; however, it is possible that this won't be the situation again.

While markets were concerned that the past would repeat, they kept calm when the Fed dropped hints about tapering in July of 2021. The yield on U.S. Treasuries stayed at 1.3% despite a recent drop from its previous high point in early April. The news about taper tantrum 2021 followed the market expectations, but the announcement in 2013 arrived sooner than expected. This might explain the discrepancy in how the market reacted to the two announcements.

This article is a guide to Taper Tantrum and its meaning. We explain the 2013 taper tantrum effect with a graph to understand the concept well. You can also go through our recommended articles on corporate finance –

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