All you wanted to know about taper tantrum

Maulik Madhu | Updated on March 01, 2021

When the yield on the 10-year US Treasury momentarily surged past 1.6 per cent last Thursday, the highest in a year, it gave many investors a sense of deja vu. It brought back memories of the 2013 ‘taper tantrum’. Last week’s events stoked fears of a replay of this.

What is it?

In May 2013, the US Fed’s announcement that it would taper its massive bond-buying programme that had been on since the global financial crisis led to a sudden sell-off in global stocks and bonds. This triggered capital outflows and currency depreciation in many emerging market economies that received large capital inflows. This episode earned the nickname taper tantrum.

The 10-year US Treasury yield has witnessed a sharp rise this year too — from 0.9 per cent to 1.4 per cent so far in 2021. Bond yields globally, including in India, have been trending up. The post-Covid period was marked by massive fiscal spending and substantial monetary easing by the US and other economies. The $1.9 trillion stimulus package proposed by Joe Biden is the latest in the series.

But as expectations of a stronger economic recovery have gained ground, inflation in commodities has been rearing its head. The possibility of inflation has also fuelled concerns that the US Fed will have to reverse its quantitative easing and raise interest rates sooner rather than later. This has given rise to the possibility of a new ‘tantrum’. Last week, such fears triggered a sell-off in the bond markets while pushing up US Treasury yields (bond prices and yields are inversely related).

Why is it important?

The last time when US Treasury yields rose sharply in 2013, it triggered an outflow of capital from emerging market economies spread over several months beginning in May 2013. In India, foreign institutional investors pulled out money from both equities and bonds. The rupee depreciated over 15 per cent between May 22 and August 30, 2013. This forced the RBI to suddenly raise interest rates to stem the outflows.

When yields on the ultra-safe US treasuries rise, investors have reduced incentive to invest in riskier assets such as equity. Also, with equity valuations running sky high especially in tech stocks, the surge in yields seemed to have provided just another nudge to equity investors to book profits. In line with the fall in equity markets globally, the Sensex and the Nifty too fell nearly 3.8 per cent on Friday as FIIs pulled out. Hardening US Treasury yields reduce the yield differential with other countries’ bonds, making them less attractive.

G-sec (government bond) yields in India too have been inching upwards lately. With a massive government borrowing plan lined up for 2021-22, an oversupply of government bonds without a commensurate demand for them has pushed up G-sec yields. Inflationary concerns and the possibility of appropriate policy action (such as a rate hike) by the RBI are fanning the fears.

Why should I care?

In the 2013 taper tantrum, the impact on the stock market was short-lived. This time, the markets are overvalued and investors fear that the yield spike can become the trigger for an extended market correction. With bond yields on the rise, not all stocks offer an attractive enough return — earnings yield (reverse of P/E ratio) plus dividend yield — today to justify investment in them. Existing investors may need to brace for a de-rating of stock valuations, new ones can perhaps look forward to a buying opportunity.

A rise in bond yields may, however, be good for investors in small savings schemes and the GOI Floating Rate Bonds, where rates are linked to government bond yields and are reset periodically. On the other hand, those invested in debt mutual funds (especially longer duration ones) and listed bonds may have to brace themselves for more mark-to-market losses if yields continue to harden.

The bottomline

A tantrum is usually short-lived, but you need to worry if it becomes a habit.

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Published on March 01, 2021

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