When Was the Taper Tantrum and What Caused It?

The “taper tantrum” refers to a significant period of market volatility experienced in 2013. This financial event highlighted the sensitivity of global markets to changes in major central bank policies, particularly those of the U.S. Federal Reserve. It emerged from a broader context of unconventional monetary measures implemented to support economic recovery following a financial crisis. The episode served as a reminder of how market expectations and communications from financial authorities can influence investor behavior and asset prices worldwide.

The Event and Its Timing

The taper tantrum unfolded over approximately three months, from May to August 2013. The catalyst for this market reaction was an announcement made by then-Federal Reserve Chair Ben Bernanke. On May 22, 2013, during a congressional testimony, Bernanke hinted that the Federal Reserve might soon begin reducing the pace of its bond-buying program.

This signal indicated a potential shift in the Federal Reserve’s monetary policy, moving away from the expansive measures that had been in place. The term “taper tantrum” describes the immediate and sharp market response to this anticipated change in policy. It captured the sudden increase in U.S. Treasury yields and the ensuing turbulence across global financial markets.

This surge in yields, indicating falling bond prices, was a direct consequence of investors re-evaluating their positions based on the potential for reduced liquidity in the financial system. The event established a clear timeline for financial adjustment and uncertainty.

Underlying Causes

The taper tantrum originated from the Federal Reserve’s extensive use of quantitative easing (QE) in the aftermath of the 2008 financial crisis. QE is a monetary policy tool where a central bank purchases large quantities of government bonds and other securities from the open market. The purpose of these purchases was to inject liquidity into the financial system, lower long-term interest rates, and stimulate economic activity during a period of low growth and high unemployment.

By 2013, the Federal Reserve’s balance sheet had significantly expanded, holding trillions of dollars in assets acquired through its QE programs. Markets had grown accustomed to this continuous injection of funds, which supported asset prices and kept borrowing costs low. The Federal Reserve’s communication strategy leading up to May 2013 involved discussions about the future of QE, but the market’s interpretation of these signals was varied.

The prospect of “tapering,” or gradually reducing the pace of these asset purchases, represented a significant policy shift. Investors worried that a reduction in the Federal Reserve’s bond-buying would lead to higher interest rates, decreased market liquidity, and potentially undermine the economic recovery. This concern about the withdrawal of substantial monetary support led to a strong market reaction.

Immediate Market Reactions

Following the Federal Reserve’s hints of tapering, financial markets experienced immediate consequences. One of the most prominent reactions was a significant increase in U.S. Treasury bond yields, particularly for the 10-year Treasury note, which surged from 1.6% in May to almost 3% by September 2013. This sharp rise in yields indicated a rapid adjustment in bond prices, as investors anticipated less demand from the Federal Reserve.

Equity markets also exhibited increased volatility and experienced declines as investors adjusted their expectations for future monetary policy. The perceived tightening of financial conditions prompted a re-evaluation of risk, leading to shifts in investment strategies. The U.S. dollar, in response to the anticipation of a less accommodative monetary stance, strengthened against other major currencies.

The impact was particularly pronounced in emerging markets. These economies, many of which had benefited from capital inflows seeking higher yields during the period of expansive U.S. monetary policy, faced significant capital outflows. This outflow led to considerable currency depreciation in several emerging market nations, alongside rising bond yields and increased borrowing costs.