The “taper tantrum” refers to an abrupt, negative reaction by financial markets to the announcement or anticipation of a gradual reduction in monetary stimulus measures, particularlyquantitative easing (QE) programs. The term was popularized in 2013 when an announcement by the U.S. Federal Reserve (Fed) regarding a possible reduction in its asset purchase program triggered high volatility on financial markets, including a rise in interest rates, a fall in equities, and a flight of capital from emerging markets.

Origin of the term “Taper Tantrum

The term “taper” refers to the gradual reduction in asset purchases under QE. The Fed had implemented massive bond-buying programs to inject liquidity into the economy after the 2008 financial crisis. In May 2013, Ben Bernanke, then Fed Chairman, hinted that the central bank might start to “tap” or gradually reduce these purchases if the US economy continued to improve.

The mere mention of a possible reduction in monetary support measures provoked a violent reaction in the financial markets, including a rapid rise in long-term interest rates and a fall in the prices of financial assets, particularly bonds. Investors, worried about the end of ultra-accommodative monetary policies, quickly sold off assets, causing high market volatility. This reaction has been dubbed the “taper tantrum”, comparing it to the behavior of a child who throws a tantrum when it doesn’t get what it wants.

Consequences of the 2013 Taper Tantrum

The market reaction in 2013 had several consequences:

1. Rising interest rates: One of the main consequences was a rapid rise in US bond yields, particularly on Treasury bills. In the space of a few weeks, the yield on the 10-year Treasury note rose from under 2% to over 3%, increasing the cost of financing for businesses and households.
2. Falling stock markets: equities fell as investors anticipated a reduction in the liquidity available in the markets, leading to profit-taking and a drop in confidence.
3. Capital flight from emerging markets: The “taper tantrum” has had a particularly strong effect on emerging economies. The announcement of the reduction in asset purchases led investors to withdraw capital from these countries on a massive scale, reinvesting in safer US assets with rising yields. This led to currency depreciation in emerging economies and tensions on their financial markets.
4. Fed intervention: Faced with market volatility and fears of destabilization, the Fed quickly clarified that the reduction in asset purchases did not mean an imminent rise in key rates, but rather a gradual adjustment to a more solid economic recovery. This helped to ease market tensions.

Reasons for the market reaction

The 2013 taper tantrum can be explained by several factors:

1. Dependence on liquidity: After several years of ultra-accommodative monetary policy, with interest rates close to zero and massive bond purchases by the Fed, investors had become dependent on this abundance of liquidity. The idea that this source of support might diminish caused a psychological shock in the markets.
2. Anticipation of rate hikes: Investors interpreted the reduction in asset purchases as a signal that the Fed might start raising interest rates sooner than expected, thereby increasing the cost of credit and curbing growth.
3. Volatility in emerging markets: Emerging markets were particularly vulnerable, as they had benefited from massive capital flows in search of higher yields due to very low rates in the USA. The prospect of higher US rates prompted investors to repatriate their funds, creating turbulence in these economies.

Taper Tantrum teachings

The taper tantrum of 2013 offered several lessons for central banks and investors:

1. Importance of communication: The taper tantrum has shown that central bank communication must be particularly clear and precise. Even an announcement perceived as vague or misinterpreted can provoke major reactions in the financial markets. Since then, the Fed and other central banks have stepped up their efforts to prepare the markets for any change in monetary policy, adopting a gradual and transparent approach.
2. Managing the reduction in asset purchases: The taper tantrum highlighted the difficulty of exiting unconventional policies such as QE without causing shocks to financial markets. Central banks need to strike a balance between the gradual reduction of these programs and market stability.
3. Vulnerability of emerging markets: The 2013 event highlighted emerging markets’ dependence on foreign capital and the fragility of their economies in the face of monetary policy changes in advanced economies. It also reinforced the importance for these countries of developing more robust sources of domestic financing.