What Is the Taper Tantrum?
The phrase, taper tantrum, describes the 2013 surge in U.S. Treasury yields, resulting from the Federal Reserve's (Fed) announcement of future tapering of its policy of quantitative easing. The Fed announced that it would be reducing the pace of its purchases of Treasury bonds, to reduce the amount of money it was feeding into the economy. The ensuing rise in bond yields in reaction to the announcement was referred to as a taper tantrum in financial media.
- Taper tantrum refers to the 2013 collective reactionary panic that triggered a spike in U.S. Treasury yields, after investors learned that the Federal Reserve was slowly putting the brakes on its quantitative easing (QE) program.
- The main worry behind the taper tantrum stemmed from fears that the market would crumble, as the result of the cessation of QE.
- In the end, the taper tantrum panic was unjustified, as the market continued to recover after the tapering program began.
Understanding Taper Tantrum
In reaction to the 2008 financial crisis and ensuing recession, the Federal Reserve executed a policy known as quantitative easing (QE), which involves large purchases of bonds and other securities. In theory, this increases liquidity in the financial sector to maintain stability and promote economic growth. Stabilizing the financial sector encouraged lending, to allow consumers to spend and businesses to invest.
Historically, quantitative easing, the monetary policy designed to infuse more dollars into the circulation of the economy, has been considered only usable as a short-term fix because of the danger that could arise from falling dollar values leading to hyperinflation. Traditional economists would insist that when the Federal Reserve feeds the economy for too long, there are unavoidable consequences. Tapering, which gradually reduces the amount of money the Fed pumps into the economy, should theoretically incrementally reduce the economy's reliance on that money and allow the Fed to remove itself as the economy's crutch.
However, since 2015, the Fed has found a variety of ways to infuse cash into the economy without lowering the value of the dollar. These new policy tools, such as the repurchase window, may have ushered in a new chapter in the future study of macroeconomic policy, though it will be several years before economists and academics, in hindsight, will be willing to declare such tools effective or dangerous.However, investor behavior always involves not just current conditions, but expectations of future economic performance and Fed policy. If the public gets word that the Fed is planning to engage in tapering, panic can still ensue, because people worry that the lack of money will trigger market instability. This is particularly a problem the more dependent the market has become on continued Fed support.
What Caused the 2013 Taper Tantrum?
In 2013, Federal Reserve Chair Ben Bernanke announced that the Fed would, at some future date, reduce the volume of its bond purchases. In the period since the 2008 financial crisis the Fed had tripled the size of its balance sheet from around $1 trillion to around $3 trillion by purchasing almost $2 trillion in Treasury bonds and other financial assets to prop up the market. Investors had come to depend on ongoing massive Fed support for asset prices through its ongoing purchases.
This prospective policy of reducing the rate of Fed asset purchases represented a massive negative shock to investor expectations, as the Fed had become one of the worlds biggest buyers. As with any reduction in demand, with reduced Fed purchases (bond) prices would fall. Bond investors responded immediately to the prospect of future decline in bond prices by selling bonds, depressing the price of bonds as a result. Of course, falling bond prices always mean higher yields, so yields on U.S. Treasuries shot up.
It is important to note that no actual sell-off of Fed assets or tapering of the Fed’s quantitative easing policy had occurred at this point. Chair Bernanke’s comments referred only to the possibility that at some future date the Fed might do so. The extreme bond market reaction at the time to a mere possibility of less support in the future underscored the degree to which bond markets had become addicted to Fed stimulus.
Many pundits believed that the stock market could follow suit, since the money flowing into the economy from the Fed through bond purchases was also widely understood to be supporting stock prices. If so, this market reaction to the prospect for Fed tapering could potentially sink the economy. Instead, the Dow Jones Industrial Average (DJIA) made only temporary declines in mid-2013.
Why Didn’t the Stock Market Fall During the Taper Tantrum?
There were many reasons for the stock market's continued health. For one, following Chair Bernanke’s comments, the Fed did not actually slow its QE purchasing, but instead launched into a 3rd round of massive bond purchases, totaling another $1.5 trillion by 2015. Secondly, the Fed professed a strong faith in market recovery, boosting investor sentiment and actively managing investor expectations through regular policy announcements. Once investors realized that there was no reason to panic, the stock market leveled out.