Introduction

The term "Taper Tantrum" has been floating around the financial market for quite some time. As childish as it sounds, it has taken the market by storm. So, what does this term exactly mean? It refers to the sudden reaction in the global financial markets when the U.S. Federal Reserve announced the reduction of its quantitative easing strategy. If you are wondering what that means, and how it impacts you as an investor, this blog is for you. Read on to learn everything you need to know about the taper tantrum.

What is a taper tantrum? Understanding the origin

The phrase "taper tantrum" was first coined in 2013 when the Federal Reserve Chairman at the time – Ben Bernanke hinted that the Central Bank would start scaling back, or tapering, its quantitative easing (QE) program. The program was focused on the purchase of government bonds to inject liquidity into the economy after the economic crisis in 2008. However, the suggestion that such support would be withdrawn caused panic across the global markets, resulting in market volatility. It especially impacted the bond market. This reaction was termed a taper tantrum.

The unfolding of the taper tantrum

As the Federal Reserve announced the possibility of tapering its QE program, there was a widespread fear of reduced liquidity. Investors reacted to this by quickly selling off bonds, which led to a spike in bond yield. This, in turn, caused a rapid outflow of funds from the emerging markets at the time. The reaction was triggered by the fear of rising interest rates.

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With the bond prices dropping and yields climbing, the cost of borrowing for governments and corporations increased, which dampened growth prospects. Some examples include the drop of 4% in the American markets and the Sensex increase of 105% between 2013 to the beginning of January, right before the pandemic.

Impact of the taper tantrum in India

The taper tantrum caused ripples in global markets, including India. During the QE phase, the Indian market bloomed with the influx of foreign capital. However, the announcement of tapering. i.e., reducing bond purchases, led to turmoil in the market. Here's what happened:

·   Immediate market reaction

When the U.S. started signalling the reduction of its QE program, the U.S. interest rates started rising. This shift drew investors back to American assets. As a result, there was a sudden outflow of foreign investments from India.

·   Decline of the Indian Rupee

One of the most significant impacts was on the Indian rupee. As investors withdrew their money, the demand for U.S. dollars surged. This consequently led to the depreciation of the rupee. The Indian currency lost considerable value against the dollar.

·   RBI's damage control

To combat the capital impact and prevent further depreciation of the Rupee, the Reserve Bank of India (RBI) raised interest rates. The move helped control inflation and stabilise the currency. However, it also made borrowing more expensive, which impacted growth aspects.

·   Inflationary pressures

As the Rupee weakened and the import costs rose, India experienced a sharp rise in inflation. The increase in prices of essential goods, especially commodities like oil, put a strain on consumers and businesses alike.

The stock market still didn't entirely crumble. How?

Contrary to initial fees, the stock market remained stable during the taper tantrum as the Federal Reserve did not halt the bond-buying program immediately. It continued to support the markets by purchasing an additional $1.5 trillion in bonds by 2015, which helped sustain investor confidence. There was also clear communication from the chairman of the Fed, which further calmed the markets.

Plus, while the bond market faced some volatility, the U.S. market weathered the tapering well. In India, concerns about tapering's impact on foreign investment proved less significant than anticipated. Between 2013 and early 2020, the Indian Sensex surged by 105%. India's markets showed only, minor, short-lived volatility. This illustrates that with gradual policy changes and clear communication, markets like India can remain resilient during periods of monetary distress.

Conclusion

The 2013 taper tantrum highlighted the vulnerabilities of emerging markets like India. They emphasised on lessons such as the risk of foreign investment dependency and the importance of strong policy adjustments. When the U.S. Federal Reserve signalled a reduction in its bond-buying program, India experienced capital outflows, a declining Rupee, and inflationary pressures. However, the Indian stock market was able to stabilise through interest rate hikes and inflation control.

As a new investor, diversifying your investments, staying informed about global monetary trends and impacts like tapering tantrums, and consulting financial advisors is the way forward. You can learn from this financial phenomenon and navigate market volatility wisely. You may also consult financial advisors to help you navigate the stock market more effectively during such scenarios. Staying up-to-date about the market can save you from unnecessary stress and losses.

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