The term “taper tantrum” might sound like a toddler’s meltdown, but in finance, it’s a serious matter. This phrase has been circulating among investors for some time. If you’re puzzled about what it means and why it matters, you’ve come to the right place. Let’s demystify this concept together.
What Is Taper Tantrum?
The term “Taper Tantrum” describes the market’s volatile reaction when a central bank, such as the Federal Reserve in the U.S., decides to gradually end its quantitative easing policy. This policy involves the central bank purchasing a set amount of government bonds and other assets to inject liquidity into the economy, especially during financial stress like the recent Coronavirus pandemic. This stimulated economic activity by lowering interest rates and increasing money supply.
“Tapering” is the methodical reduction of these asset purchases by the central bank, effectively decreasing the amount of money it feeds into the economy. This approach aims to ease the economy off of the additional financial support provided during crises.
The concept of tapering is not new, but it became widely discussed and impactful in 2013, a period marked by advanced digital communication, which facilitated the rapid dissemination of information. The term “Tantrum” reflects the intense reaction from investors and the market following announcements of reducing quantitative easing, fearing potential negative impacts on investments.
While initially observed in the U.S., this phenomenon has implications worldwide, affecting global economic stability and influencing currency values, as seen in the past and recently with the rise in U.S. bond yields reaching record levels.
What Exactly Happened in 2013 With Taper Tantrum?
The 2008 financial crisis led to widespread panic and the selling of shares and bonds. In response, the U.S. Federal Government quickly began purchasing large amounts of government bonds and implemented other quantitative easing actions. These efforts were designed to keep lending rates low and boost liquidity in the market, reassuring investors about the future.
These low lending rates encouraged more borrowing, increased consumer spending, and allowed businesses to expand their investments. From 2008 to 2015, the U.S. Government injected approximately $4.5 trillion into the economy, a significant increase from the $870 billion total before 2007.
However, it’s crucial to recognise that using capital injections to stabilise the economy is a temporary fix and could lead to hyperinflation if extended over a long period.
By 2013, as the U.S. economy began to recover, the government planned to scale back its quantitative easing program. This decision led to a 4% drop in the American markets and triggered a global reaction. The widespread use of digital platforms by investors amplified this response, causing global markets to react adversely to news that should have been anticipated.
Impact of Tapering on India
The 2013 surge of global investors initially fueled a boom in Indian markets, but this was soon disrupted due to changes in U.S. monetary policy. As the U.S. began to cut back on its bond-buying program, it sparked a wave of panic. Here’s what happened next:
- Immediate shift: Once the tapering started, U.S. interest rates gradually increased, drawing investors back to American assets. This led to a significant withdrawal of foreign investments from India.
- Decline of the Rupee: As dollars were pulled out, the Indian Rupee suffered, losing value against the dollar.
- RBI’s response: To control the fall of the Rupee and manage the outflow of funds, the Reserve Bank of India (RBI) was forced to raise interest rates. Although necessary, this decision brought its own problems.
- Inflation rises: With the dollar strengthening and the cost of imports rising, inflation began to increase, impacting everyday prices for consumers.
- Wider impact: The turmoil wasn’t confined to India. Other emerging economies such as Turkey, Brazil, and Indonesia also experienced challenges, with their currencies losing value due to the abrupt investment withdrawals.
Impact of Tapering on Stock Markets
Following the tapering, many anticipated severe downturns in the stock markets.
However, the actual effects were mitigated and brief. During tapering in the U.S., as bond yields and interest rates increased, the U.S. stock market managed well, and the influence on Indian markets was very small. From 2013 to January 2020 (just before the Pandemic), the Sensex actually increased by an impressive 105%.
In 2020, amidst the pandemic, the U.S. Federal Government resumed buying government bonds and assets. Currently, the government is purchasing securities totaling $120 billion from the market. Last month, there was a suggestion of another tapering by reducing the bond-buying program.
Since investments from the U.S. into India haven’t been significant since the bond purchases resumed, India might not suffer greatly from potential investor withdrawals. Despite recent tapering announcements, Indian markets experienced only minor volatility and dropped by just 1%—a loss that was quickly regained, maintaining its high performance.
Still, the stock market remains largely unpredictable, and it’s wise for investors to be cautious with their market positions. Consult with financial advisors before making investments.
Also Read More About Impact of Monetary Policy on Stock Markets in India
Wrapping Up
The ‘taper tantrum’ story highlights how closely global economies are linked and the recurring nature of financial events. For India, these episodes underscore the importance of not being distracted by short-lived market swings. Instead, they emphasise the need to concentrate on the larger economic outlook and growth opportunities.
Moving forward, it’s vital for investors to bear these insights in mind, equipping themselves to manage the complexities of global finance adeptly. To navigate these market conditions effectively and take control of your investment journey, consider opening a Demat account with Angel One.
FAQs
What are taper tantrums?
Taper tantrums describe market instability triggered when the Federal Reserve signals a reduction in its quantitative easing policy, impacting global financial markets.
When was the taper tantrum period?
The term originated during mid-2013 when the U.S. Federal Reserve first indicated plans to reduce its bond-buying activities, causing global market fluctuations.
When was the taper tantrum in 2013?
The 2013 taper tantrum occurred in May, following then-Fed Chairman Ben Bernanke’s hint at tapering the quantitative easing during a Congressional testimony.
What is the taper effect?
The taper effect refers to the economic and market reactions, typically negative, that occur when a central bank gradually withdraws from bond-buying programs intended to stimulate the economy.
