All you need to know about taper tantrum

Summary: Discover the story of 'taper tantrums' and its ripple effects on global economies, especially India. Learn how shifts in U.S. monetary policy can lead to significant financial repercussions, from the rupee's value to stock market fluctuations. Equip yourself with the knowledge to navigate these changes and understand the importance of a long-term perspective in investments.

Ah, the taper tantrum. It sounds like a child's outburst, but in the world of finance, it's anything but childish. This term has been buzzing around the investment community for a while now, and if you're scratching your head wondering what it's all about and why you should care - then you're in the right place. Let's unravel this mystery together.

What is a taper tantrum?

In more technical terms, a taper tantrum occurs when a central bank, like the U.S. Federal Reserve, hints or announces that it's going to scale back (or "taper") its asset-buying program. This announcement can send shockwaves through the investment community. Why? Because investors, fearing a potential rise in interest rates and a less accommodating monetary environment, decide to pull their money out of both equities and bonds. The result? A sharp fall in bond prices.

And while this may seem like just another piece of financial jargon, the reality is that this "tantrum" can have a significant impact on more than just the US – it impacts India and the investments of its citizens – like you. When bond prices fall, their yields (or interest rates) rise. Higher interest rates can make borrowing more expensive for companies and individual investors such as yourself. This can potentially slow down economic growth, reduce stock prices, and hurt the returns on your investments. 

So, read on and discover the story of taper tantrums and the lesson it has for our future.

Our story begins 

Remember the tumultuous economy of 2008? The world faced one of its most severe financial crises. Stock markets plummeted, businesses shuttered, and panic was the order of the day. Investors, in a frenzy, pulled their money out of stocks and bonds, seeking safer havens. Recognizing the gravity of the situation, the US government sprang into action. Their weapon of choice? A monetary policy tool called quantitative easing (QE).

In layman's terms, QE was like giving the economy an electric shock. The US government started buying bonds, pumping money into the system, ensuring there was enough liquidity flowing around. This move also had the effect of keeping interest rates at rock-bottom levels. For investors, this was like a beacon in the night, signalling that perhaps brighter days were still ahead.

The twist in the tale

With low-interest rates, borrowing money became cheap. Consumers, feeling a bit more confident, started opening their wallets wider. Businesses, sensing an opportunity, ramped up their investments. The economy was humming along, and it seemed like the worst was over. But here is the twist in our tale.

As the saying goes, "What goes up must come down." And in May 2013, Ben Bernanke, the then-Chairman of the United States Federal Reserve, dropped a bombshell. He hinted that the Federal Reserve was thinking about reducing, or "tapering," its asset purchases. In other words, the financial safety net the Fed had put in place might soon be pulled away.

The reaction in the financial world was swift and dramatic. Imagine being at a party, and someone yells, "The snacks are running out!" Everyone rushes to grab the last few chips. Similarly, investors, fearing the end of easy money, began selling off their bonds.

But here's where it gets interesting: Instead of reinvesting in the US, many investors started looking for greener pastures elsewhere. They sought countries where returns seemed more guaranteed. This massive movement of money had a cascading effect, especially on emerging economies. Suddenly, these nations found themselves grappling with an influx of foreign investments, which, while beneficial in some ways, also came with its own set of challenges.

Impact on India

While the 2013 influx of global investors led to an invest boom in Indian markets it was quickly disrupted once again due to a shift in U.S. monetary policy. As the U.S. hinted at reducing its bond-buying program, a sense of panic set in. Here's the sequence of events that followed:

1. The sudden reversal: As soon as the tapering began, U.S. interest rates started inching upwards, making American assets more attractive. The result? A massive pull-out of foreign investments from India.
2. The Rupee's tumble: With dollars flowing out, the Indian Rupee took a hit. Its value against the dollar plummeted.
3. RBI's countermove: To stem the Rupee's fall and combat the outflow of foreign funds, the Reserve Bank of India (RBI) had no choice but to hike interest rates. While this move was necessary, it came with its own set of challenges.
4. The inflation monster: A stronger dollar and costlier imports meant that prices started rising. Inflation began to rear its ugly head, affecting the common man's pocket.
5. Global contagion: India wasn't alone in this turmoil. Other emerging markets like Turkey, Brazil, and Indonesia also felt the heat, with their currencies depreciating due to the sudden pull out of investments.

Stock market resiliency

With all this chaos, one would assume that the stock markets were headed for a nosedive. But here's where the resilience of financial markets shines through. Yes, there was an initial jolt, but it was transient. The U.S. stock market, after its momentary wobble, not only recovered but thrived. Moreover, this positive sentiment spilled over to the Indian market. 

The result? From 2013 to 2020, the Sensex surged by an impressive 105%. 

In essence, while the taper tantrum of 2013 was a roller-coaster ride for the Indian economy and its investors, it also underscored the importance of staying informed, being resilient, and having a long-term perspective in the world of investments. And as a result, every subsequent rumour or fear of another tapering has been met with Indian financial markets demonstrating minimal volatility.

Conclusion

The story of the 'taper tantrum' serves as a poignant reminder of the interconnectedness of global economies and the cyclical nature of financial events. For India, the taper tantrums, both past and recent, remind us that we shouldn’t get swayed by short-term market fluctuations. Instead, they highlight the need to focus on the broader economic picture and the potential for growth. So, as we move forward, it's crucial for investors to remember these lessons, ensuring that they are well-equipped to navigate the ever-evolving landscape of global finance. After all, in the world of investments, knowledge is not just power; it is profit.

Disclaimer

The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.