When the yield on the 10-year US Treasury momentarily surged past 1.6% last Thursday, the highest in a year, it gave many investors a sense of déjà vu. It brought back memories of the 2013 ‘Taper Tantrum’.
What is Taper Tantrum?
Before we get to the Taper Tantrum episode, we need to talk about the global financial crisis of 2008. At the time, the Federal Reserve also known as the US Central Bank had the daunting task of supporting a domestic recovery. At first, they nudged the interest rates, in a bid to make borrowing more accessible. But soon, interest rates began approaching zero. Banking institutions were now borrowing from the central bank for short durations without paying any interest. And it still wasn’t enough. The central bank had to do more. So, they resorted to unconventional methods. The Federal Reserve came up with a new plan — Quantitative Easing (QE). They bought all toxic assets/unpaid loans for a lot of money and helped commercial banks shore up their reserves. This introduced a lot of new money into the banking ecosystem.
To understand Taper Tantrum better let us first look at the below definitions:
i. Quantitative Easing (QE) is a form of unconventional monetary policy in which a central bank purchases long-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank’s balance sheet.When short-term interest rates are either at or approaching zero, the normal open market operations of a central bank, which target interest rates, are no longer effective. Instead, a central bank can target specified amounts of assets to purchase. Quantitative Easing increases the money supply by purchasing assets with newly-created bank reserves in order to provide banks with more liquidity.
ii. Tapering is the gradual reversal of a quantitative easing policy implemented by a central bank to stimulate economic growth. As is the case with most, if not all, economic stimulus programs, they are meant to be unwound once officials are confident that the desired outcome, usually self-sustaining economic growth, has been achieved.
In May 2013, the US Fed announced that it would taper its massive bond-buying programme i.e Quantitative Easing Programme that had been on since the global financial crisis. This led to a sudden sell-off in global stocks and bonds and triggered capital outflows and currency depreciation in many emerging market economies that received large capital inflows. This episode earned the nickname taper tantrum.
In June 2013, financial markets interpreted statements by the chairman of the Federal Reserve Ben Bernanke as suggesting that a tighter monetary policy was in the offing when that was apparently not his intention. Thinking the “taper” of the Fed’s bond purchasing program, known as “quantitative easing” was imminent, markets reacted with an immediate spike in US bond yields and the value of the dollar and prolonged stress in some emerging markets. Among the worst-hit “Fragile Five” (Brazil, India, Indonesia, Turkey, and South Africa), the buoying effect of foreign capital inflows into their countries was temporarily reversed, and their currencies sharply depreciated.
When US Treasury yields rose sharply in 2013, it triggered an outflow of capital from emerging market economies spread over several months. 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. A share erosion in the value of Rupee can have a detrimental impact on the country. Oil becomes expensive, gold becomes expensive. It’s a shock that can be difficult to reverse.
Current Market Scenario
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.
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.
The possibility of inflation has also fueled 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’.
Why recap?
In an interview with BloombergQuint, Raghuram Rajan, while discussing the global outlook of the economy and the effects of the pandemic on emerging markets, suggested another Taper Tantrum episode might be on its way.
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.
This post was written in collaboration with Asif Yahiya Sukri LLP. Asif Yahiya Sukri LLP provides unparalleled personalized financial services to a broad range of clients across different geographical locations. With a presence in the USA, India and the MENA region, they ensure that all of your financial decisions are made carefully and with your best interests in mind. They are innovators who understand what goes into building companies.
You can also reach out to them on info@aysasia.com
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