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What Is A Taper Tantrum? Understanding the Financial Phenomenon

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Taper Tantrum is one of the biggest examples showcasing the impact of the US’s federal bank policies on the Indian economy. While the term “Taper Tantrum” sounds childish, the impact it has can not be any further away. Before we proceed with the details, know that Taper Tantrum simply refers to the market reaction to the U.S. Federal Reserve's announcement to scale back its asset-buying program, specifically the reduction of its quantitative easing (QE) measures.

Let’s dive straight into the taper tantrum meaning and how it moves the stock market. 

What Is the Meaning of a Taper Tantrum?

Taper Tantrum is a common financial term that stems from the infamous 2013 act of the US Federal Bank announcing its decision to taper its policy of quantitative easing in the future. 

Simply put, the bank decided to scale down the purchases of treasuries and other financial assets to cut down the money it puts in the market. The reaction in the stock market and the ensuing rise in bond yields was referred to as Taper Tantrum by the media.  

The biggest fear amongst the financial experts was that the cessation of quantitative easing would crumble the economy, especially the bond market

The Mechanics of Taper Tantrum

Let’s understand how taper tantrums work by taking the 2013 example. 

The Federal Reserve is regarded as one of the most influential central banks globally, especially in terms of its impact on the U.S. dollar and global financial markets. It is engaged in purchasing bonds to keep the long-term interest rates low—a vital factor for economic growth.

This method was called quantitative easing and was adopted in 2008 to overcome the recession by buying large securities to regulate the interest rates. 

The slightest hint of QE ceasing brought the economic market under a rampage as the fear of rising interest rates and a crumbling economy crept in. 

Impact on Financial Markets

Taper Tantrum had severe impacts on the financial market, and over time was considered largely unjustified. The global market marked a significant decline in stock prices due to the anticipation of reduced liquidity. 

Let’s explore how the financial markets in India faced turmoil due to taper tantrums:

  • Indian Rupee Tumbled

As dollars started to flow out because of attractive American assets, the Indian rupee against the US dollar plummeted.

  • Rise in Interest Rates

To overcome the falling prices of the Indian rupee, the Reserve Bank of India implemented several measures, including increasing interest rates.

  • Rise in Inflation

Dollars became strong and an increase in the prices of imports raised the inflation rate in India once again despite the measures taken to combat the 2008 recession. 

What is the Significance of Taper Tantrum? 

Now that you have understood the taper tantrum meaning, it’s time to find answers on its significance and whether it was even as big as the financial market made it.

  • The after-effects of the Taper Tantrum significantly impacted the decisions and approach of the policymakers showcasing the importance of following clear and transparent communication to prevent panic based on misrepresentation and market manipulation.

  • Additionally, the panic created was a wake-up call for the global market to realise the ill effects of dependency on the Federal Reserve’s policies. However, it was not solely about dependency on the Fed but also about the broader implications of global monetary policy shifts.

  • The central bank’s taper tantrum marks a significant turn for the investors who earlier did not imagine such a hike in interest rates and market fluctuations.

Reasons for the Stock Market's Stability Amid the Taper Tantrum

Let’s see how the stock market can continue being stable amid taper tantrum:

  • Diversification

Investors putting their money in different types of securities helps the market stay afloat even when the central bank decides to reduce its purchasing pace. However, it is important to note that tapering generally leads to broad market volatility, and stability is not guaranteed.

  • Risk Management Policies

Taper Tantrums impact the stock market largely because of the unpreparedness to face fluctuations and hike in interest rates. Developing risk management strategies keeps the investors stable which translates into a stable stock market. 

  • Less Reliance on Imports
    A focus on creating self-reliant investment opportunities can help the country face a taper tantrum better, but the turmoil was primarily driven by capital outflows and rising interest rates.

Lessons Learned from Taper Tantrum

The Taper Tantrum was a significant event in financial history not just for India but the whole world. However, it has its positive impacts in teaching lessons to build a better economy to face turmoils with advance policies. Here are the lessons learnt from the taper tantrum:

  • Dependency on Federal Bank

The biggest lesson of Taper Tantrum was the realisation of the extreme dependency on the Federal Bank and how it can severely impact India’s economy. 

  • Self-Reliant Methods

Investors, traders and policymakers needed to come together to make India self-reliant rather than depending on imports from the US and the policies of the Federal Bank.

  • Need for Transparency

The Taper Tantrum was an impact of the Federal Bank slightly hinting towards ceasing QEs that turned the financial markets within the blink of an eye, making everyone realise the importance of transparency in the system. 

Conclusion

The Taper Tantrum of 2013 is a crucial part of the world economic history that had severe impacts, possibly based on mere speculations rather than the actual reality. While the effects were severe, taper tantrums taught crucial lessons on the importance of developing strong policies and moving away from the reliance on the Federal Bank.

India being a developing country, at that point, adopted several new measures and this period also marked the beginning of self-reliant trading and investing methods. 

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://bit.ly/3Tcsfuc

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Frequently Asked Questions

What is the meaning of a taper tantrum?

Answer Field

Taper Tantrum is a term used to describe the Federal Bank’s 2013 policy of QE cessation that left the world economy in shock. QEs cessation was the federal bank’s decision to cut down on its purchasing power thus decreasing the money it puts in the market.

What causes a taper tantrum?

Answer Field

A Taper Tantrum is caused by the decline in the central bank's purchasing frequency thus giving rise to increased interest rates.  

How does a taper tantrum affect bond markets?

Answer Field

As the central bank decides to reduce its pace of purchasing assets, bonds, stocks and all other types of securities face a rise in interest rates to curb the lack of money in the market.

What are the effects of a taper tantrum on stock markets?

Answer Field

Taper Tantrum has its impacts on the stock markets as the anticipation of reduced liquidity translates into a flight from riskier assets thus decreasing the stock prices and increasing interest rates on investments. 

Can you provide an example of a historical taper tantrum?

Answer Field

The biggest example of Taper Tantrum that the world economy saw was the Federal Bank’s 2013 policy of quantitative ceasing i.e. a decision to cut down on the bank’s purchasing pace.

What are the long-term implications of a taper tantrum for investors?

Answer Field

Taper Tantrum impacts investors in the long run majorly due to the sudden spike in interest rates and market fluctuations thus making them realise the importance of diversification and preparing a risk management strategy. 

How can investors prepare for or mitigate the impact of a taper tantrum?

Answer Field

Investors are largely impacted by taper tantrums and therefore they need to develop risk management strategies like diversification, Demat and Trading accounts to find new opportunities and rely on investments that make the country self-reliant. 

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