What Is the Taper Tantrum?
Let me explain the taper tantrum directly: it's the term for the 2013 surge in U.S. Treasury yields that happened when the Federal Reserve announced it would start reducing its bond purchases under its quantitative easing policy. The Fed said it would slow down buying Treasury bonds to cut back on the money it was injecting into the economy. This led to a rise in bond yields, and the financial media called this reaction a taper tantrum.
Key Takeaways
- 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
To understand this, consider the context after the 2008 financial crisis and recession. The Federal Reserve implemented quantitative easing (QE), buying large amounts of bonds and securities to increase liquidity in the financial sector. This was meant to stabilize things and promote growth by encouraging lending, so consumers could spend and businesses could invest.
Historically, QE is seen as a short-term fix because pumping too many dollars into the economy risks hyperinflation from falling dollar values. Traditional economists argue that if the Fed supports the economy too long, consequences are inevitable. Tapering gradually reduces this support, helping the economy stand on its own without the Fed as a crutch.
But since 2015, the Fed has developed new ways to add cash without devaluing the dollar, like the repurchase window, which might change how we view macroeconomic policy. It'll take years for economists to judge if these tools are effective or risky. Remember, investor behavior depends on expectations of future Fed actions. If word gets out about tapering, panic can hit because people fear market instability from less money, especially if the market is hooked on Fed support.
What Caused the 2013 Taper Tantrum?
In 2013, Federal Reserve Chair Ben Bernanke announced that the Fed would eventually reduce its bond purchases. Since the 2008 crisis, the Fed had tripled its balance sheet from about $1 trillion to $3 trillion by buying nearly $2 trillion in Treasury bonds and assets to support the market. Investors had grown reliant on this massive ongoing support for asset prices.
This announcement of potential tapering was a big shock to expectations, since the Fed was one of the world's largest buyers. Reducing demand would lower bond prices, so investors sold bonds right away, driving prices down and yields up on U.S. Treasuries.
Importantly, no actual tapering or asset sell-off happened yet; Bernanke only mentioned the possibility for the future. The bond market's extreme reaction showed how addicted it had become to Fed stimulus. Many thought the stock market might crash too, since Fed money was propping up stocks, but the Dow Jones Industrial Average only dipped temporarily in mid-2013.
Why Didn’t the Stock Market Fall During the Taper Tantrum?
Several factors kept the stock market healthy. After Bernanke's comments, the Fed didn't slow QE but started a third round of massive purchases, adding another $1.5 trillion by 2015. The Fed also expressed strong confidence in recovery, improving investor sentiment through regular announcements. Once investors saw no real cause for panic, the market stabilized.
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