From the archiveCase study · May–Sep 20135 min read
The taper tantrum: when ‘less QE’ felt like tightening
A hint that the Fed would slow its $85bn-a-month bond buying sent the 10-year Treasury yield from about 1.6% to 3% in four months, pushed US mortgage rates up more than a percentage point and hammered emerging-market currencies.
A hint on 22 May 2013 that the Fed would slow its $85bn-a-month bond buying sent the 10-year Treasury yield from about 1.6% to about 3% by early September.
US mortgage rates jumped from 3.35% to 4.58% with no change in Fed policy, and money fled emerging markets: the Indian rupee hit a record low of 68.85 per dollar.
On 18 September the Fed surprised markets by not tapering, and yields fell back. The taper finally came on 18 December: a $10bn cut, to $75bn a month.
The trader’s angle
Markets trade the path, not the step: a central bank’s words can tighten financial conditions worldwide before any policy changes.
10-year Treasury yield, early-Sep peak
3%
up+137bp from 2 MayUp from about 1.6% in early May: a huge four-month move for the world's benchmark bond, with no change in Fed policy.
Fed bond buying (QE3)
$85bn
unchangeda month, unchanged all summer$45bn of Treasuries plus $40bn of mortgage-backed securities. Markets moved on the hint of a cut, not on any actual change.
US 30-year mortgage rate
4.58%
upfrom 3.35% on 2 MayFreddie Mac's weekly survey on 22 August: Fed words alone raised borrowing costs for American home buyers.
Indian rupee, record low
68.85
downper $ on 28 AugIt fell 3.7% that day alone, its biggest one-day fall since 1995, as money fled countries that relied on foreign funding.
Under , a central bank creates money to buy bonds, adding a huge, price-insensitive buyer to the market. That pushes long-term down, and with them the rates on things like mortgages.
To means slowing the pace of those purchases before stopping. The central bank is still buying, so technically it is still easing, just less.
But markets look ahead. A taper means fewer bonds bought in future, so private investors will have to hold more of them, and they demand a higher to do so. It also signals that the first rate rise is getting closer. That’s why a taper can move markets as if rates had already gone up.
What happened
In spring 2013 the Federal Reserve was buying $85bn of bonds a month. That was $45bn of and $40bn of . On Wednesday 22 May, Ben Bernanke told Congress’s Joint Economic Committee that ending stimulus too early would risk the recovery.
But in the questions that followed, he said that if the improvement continued, the Fed could ‘take a step down in our pace of purchases’ in the next few meetings. Markets heard only the second part.
On 19 June, Bernanke sketched a timetable: slow purchases later in 2013 and end them around mid-2014, when unemployment would be near 7% — all conditional on the data. The sell-off accelerated.
The 10-year Treasury yield, about 1.6% in early May, hit about 3% in early September, nearly doubling with no change in Fed policy. Home loans followed: the average US 30-year mortgage rate jumped from 3.35% to 4.58%.
Why it happened
Tapering is still easing: the Fed would keep adding bonds, just more slowly. But markets price the whole path, not the next step — and three things changed at once.
First, the end of QE came into view. A huge, price-insensitive buyer would soon stop adding to its holdings, so private investors would have to hold more . They demanded a higher term premium, and interest-rate volatility jumped.
Second, rate hikes seemed closer. Bernanke likened tapering to easing off the accelerator rather than hitting the brakes, but investors treated it as the first step towards a higher .
Third, positioning was crowded. Years of easy money had pushed investors into long-dated bonds and higher-yielding in search of return. When US yields rose, everyone headed for the same exit.
How it ripples through markets
How a hint became a global tightening
- 1
Bernanke hints at slowing QE
22 May: purchases could be stepped down in the next few meetings. 19 June: a timetable to finish around mid-2014.
- 2
Markets price the whole exit
up10y Treasury yieldLess Fed buying ahead leaves private investors to hold more bonds, and they want a higher term premium to do so; the first rate hike also looks closer.
- 3
Borrowing costs jump
upUS mortgage ratesMortgage rates, which follow long-term Treasury yields, rise more than a percentage point without the Fed changing anything.
- 4
Money leaves emerging markets
downEM currenciesHigher US yields make dollar-funded carry trades less attractive, and investors pull out.
- 5
Deficit countries hit hardest
downIndian rupeeThe Fragile Five need foreign funding most; the rupee hits a record low of 68.85 per dollar.
- 6
The Fed blinks
down10y Treasury yield18 September: no taper after all, so the exit looks further off and yields fall back. The first cut in purchases comes in December.
Why it mattered for traders
The shock travelled fast. Higher US yields made — borrowing cheaply in dollars to buy higher-yielding emerging-market assets — far less attractive, and money flowed out. Emerging-market currencies fell about 6% against the dollar on average in the four months after Bernanke’s first taper comments.
The hardest hit were countries with , which depend on foreign money to pay their way. In August, Morgan Stanley analyst James Lord dubbed the most exposed the : Brazil, India, Indonesia, Turkey and South Africa. On 28 August the Indian rupee hit a record low of 68.85 per dollar, down 3.7% in a single day.
The lesson: a shift in the Fed’s outlook is a global event. When US yields jump, look for the countries that need foreign funding — that’s where the pain concentrates.
What happened next
On 18 September, markets were positioned for the first cut in purchases. Instead, the Fed said it would ‘await more evidence that progress will be sustained before adjusting the pace of its purchases’. The 10-year yield fell more than 15 that afternoon and US stocks hit record highs; by late October the yield was around 2.5%.
The taper finally came on 18 December 2013: purchases were cut by $10bn, to $75bn a month from January. That meant $40bn of Treasuries and $35bn of MBS, with further measured steps likely if the economy kept improving. Lessons were learned: eight years later, when the Fed prepared another taper in 2021, there was no repeat tantrum.
Academy lessons for this story
- F8Central banks and the policy rateExplain how a central bank sets interest rates, read the market’s odds of a move, and match each of its tools to a problem.
- R5Supply, auctions and relative valueTell whether a government bond auction went well, explain why the newest bonds yield a little less, and say how heavy borrowing moves the curve.
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Sources
- Federal Reserve — Transcript of Chairman Bernanke's press conference, 19 June 2013
- Federal Reserve — FOMC statement, 18 September 2013
- Federal Reserve — FOMC statement, 18 December 2013
- Bank for International Settlements — September 2013 Quarterly Review: Markets precipitate tightening
- Federal Reserve Bank of Dallas — Don't look to the 2013 tantrum for the effect of tapering on emerging markets
An original summary written from the sources above. Figures are rounded; follow the links for the full record.
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