Who knew markets could throw tantrums too?
That’s exactly what happened in the year 2013 – when the market collectively reacted to the possibility of the Fed stopping it’s large-scale bond purchase program.
Concept: What was the”Bond-purchasing” program about?
The Fed started purchasing large amounts of treasury bonds and other financial assets, in order to increase the money-supply in the markets as a reaction to the Global Financial Crisis of 2008.
This process of purchasing bonds and securities from the market by the Central Bank is called “Quantitative-Easing”, one of the tools utilised when the economy is in contraction.
Anyway, what the purchase of financial securities by the Fed leads to is an increase in money supply in the economy; greater the money-supply in the markets, more the spending by the people and consequently an increase in demand in the economy.
Case Study: The Taper Tantrum
Fast forward to the year 2013, the Fed considered the idea that they should “taper” down the spending via the bond-purchase program. When this news took to the markets, the bond-investors completely and collectively freaked out. Why? Because as the Fed decreases the amount of bonds purchased, that subsequently decreases the demand for bonds, which leads to lowering of bond prices. So of course, the bond investors were not happy, because this possible move would decrease their investment value.
So what did they do after freaking out? They started panic-selling the bonds. This massive sell-off led to a stark decline in the price of bonds. Since there’s an inverse relationship between bond prices and interest rates (lower the price, higher the interest rate demanded and vice-versa),the interest rates on U.S. Treasuries shot up!
In short: The Fed didn’t actually stop the bond-purchasing program, they only suggested that they MIGHT do so in the future and the bond-market threw a tantrum in reaction! That’s what the Taper Tantrum was all about. Eventually, the Fed decided not to stop the bond-purchasing program and in fact went ahead with a third round of Quantitative-Easing and purchased bonds amounting to 1.5 trillion dollars by 2015!