The term Taper Tantrum might sound a bit difficult at first to a layman, but it can be clearly comprehended if one understands the notion of Quantitative Easing. Quantitative Easing (QE) is an unconventional monetary technique in which a central bank purchases a significant quantity of securities in order to boost the economy's development. As QE succeeds, the increased money supply increases lending, decreases interest rates, and encourages economic development. However, there is a catch. A constant growth in the money supply may result in excessive inflation and a decline in consumer purchasing power. Thus, closing QE needs to be done at intervals. This is called tapering.
Tapering may signify a slowdown of bond purchases, which might result in a central bank's quantitative easing (QE) strategy being reversed. When QE measures have had the intended impact of boosting and stabilising the economy, tapering is implemented. Taper Tantrum refers to the aftermath of QE Taper.
Most people will recall the Global Financial Crisis' impact not just on people's lives throughout the world, but also on financial markets and the performance of billions of dollars in securities. (Pacella, 2021) To mitigate the economic consequences of the financial crisis, the Federal Reserve implemented an asset purchasing program to purchase US Treasury notes and mortgage-backed securities in an effort to provide liquidity in the economy and promote stability.
The quantity of assets held on the Fed's balance sheet expanded considerably during the next three years.
Source: FRED, Forbes
To help the market, the Fed expanded its balance sheet from around $1 trillion to more than $3 trillion by purchasing almost $2 trillion in Treasury notes and other financial assets.
In 2013, while the globe was emerging from a global financial crisis, Fed Chair Ben Bernanke stated in a congressional hearing that if economic circumstances steadily improved, the Fed would "take a step back in their pace of purchases." The market reacted immediately. This would entail a reduction in government bond purchases, thus restricting the quantity of money injected into the US economy. The decision to reduce bond purchases was not well welcomed by investors, who reacted instantly to the potential of further bond price declines by selling bonds, falling bond prices, and driving up yields.
Impact On Emerging Economies
The impact of the Taper tantrum was felt not just in the United States, but also in developing economies. As a result, when the Fed chose to discontinue its quantitative easing program, capital inflows into developing countries reversed. The financial market volatility was felt most acutely in India and Indonesia, which were experiencing expanding current account deficits as well as other macroeconomic imbalances. This instability, called the taper tantrum, adversely affected practically all developing markets and increased worries of a financial collapse. (Roychoudhury, 2021)
Emerging markets, notably the "fragile five" of Brazil, India, Indonesia, Turkey, and South Africa, suffered as foreign money withdrew and currencies sank dramatically. (Taper Tantrum 2, 2021)
Source: Schroders
Why are some investors concerned about a sequel?
As the global economy came to a halt because of the COVID-19 outbreak, central banks and governments pumped money into their own economies through various stimulus programs. In June 2020, the Fed announced a monthly purchase of at least $80 billion in Treasuries and $40 billion in business and residential mortgage-backed securities. Investors have turned to risky investments to produce returns or satisfy commitments when bond yields and interest rates have fallen as a result of market support. However, when economies recover, there are concerns that central banks would turn off the economic tap, causing inflation to rise. The main concern is that the Fed, which has expanded bond purchases, will have to reverse quantitative easing and hike interest rates once more.
But times have changed. India currently has $582.27 billion in foreign reserves, up from $275 billion in August 2013. As a result, authorities are more confident that the economy will be able to deal with a taper tantrum-like situation if it arises. As a result, a gradual withdrawal of liquidity infusions, along with cautious communication across economies, might eliminate the chance of another taper tantrum that would disrupt financial markets. (Advisors, 2020)
REFERENCES:
Advisors, G. (2020, May 28). Taper Tantrum and It’s Effects On Emerging Markets. Galactic Advisors. https://www.thegalacticadvisors.com/post/taper-tantrum-and-its-effects-on-emerging-markets
Pacella, M. (2021, July 23). The Story of the Taper Tantrum of 2013. Mason Stevens. https://masonstevens.com.au/the-story-of-the-taper-tantrum-of-2013/
Roychoudhury, A. (2021, March 26). EXPLAINED | The 2013 Taper Tantrum and why its spectre is being raised again. Moneycontrol. https://www.moneycontrol.com/news/business/economy/explained-the-2013-taper-tantrum-and-why-its-spectre-is-being-raised-again-6700731.html
Taper Tantrum 2: is there a sequel in the making? (2021, January 21). Schroders. https://www.schroders.com/pl/bm/asset-management/insights/fixed-income/taper-tantrum-2-is-there-a-sequel-in-the-making/
Very Insightful!