This caused a sell-off in the bond market and a spike in interest rates.. The Taper Tantrum of 2013: What It Is and What Caused It
How tapering affects stock market?
The Federal Reserve's Open Market Committee (FOMC) decides on the target federal funds rate. The federal funds rate is the rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. The target federal funds rate is set at a level that is intended to foster economic growth and stability.
The FOMC minutes from the December 2013 meeting stated that the Committee would begin tapering its asset purchase program, commonly referred to as quantitative easing (QE), in January 2014. The Committee said it would reduce the monthly pace of asset purchases by $10 billion at each FOMC meeting, with the goal of ending the program by the end of 2014.
The FOMC's decision to begin tapering its asset purchase program was widely expected by market participants. The stock market rallied in the days leading up to the announcement and then sold off after the announcement. The sell-off was driven by fears that the Fed would begin to raise interest rates sooner than expected.
The sell-off in the stock market continued in the following weeks as the Fed continued to reduce the monthly pace of asset purchases. By the end of 2014, the Fed had ended its asset purchase program and the stock market had recovered from its sell-off.
The impact of the Fed's asset purchase program on the stock market is difficult to quantify. Some market participants believe that the asset purchase program helped to support the stock market by keeping interest rates low. Others believe that the program had little impact on the stock market.
What happens during tapering? When the Federal Reserve decides to taper, it means they are reducing the amount of monthly bond purchases they are making. This process starts with the Fed selling some of the bonds they have acquired through quantitative easing back into the market. This causes rates to rise and the prices of bonds to fall. The Fed will continue to sell bonds until they are no longer buying any new bonds. This process can take several months. How does tapering control inflation? When the Federal Reserve wants to slow the economy, it does so by raising interest rates. This makes it more expensive for companies to borrow money for expansion, and also makes it more attractive for consumers to save rather than spend.
One way the Fed raises rates is by selling bonds. This reduces the supply of bonds available, and therefore drives up bond prices. When bond prices rise, the yield (the effective interest rate) falls.
The Fed can also influence rates by changing the size of the bond market. If the Fed wants to raise rates, it buys bonds (known as quantitative easing). This reduces the supply of bonds and pushes up prices, and therefore rates.
The opposite is true if the Fed wants to lower rates. In this case, it would sell bonds, increasing the supply and pushing down prices (and rates).
What is meant by taper tantrum? When bond prices fall, the yield (effective interest rate) rises. This is because investors require a higher yield to compensate them for the lower price. The higher yield causes the value of the bond to fall further, and the cycle repeats. This is known as a "taper tantrum." When did the Fed start tapering? The Federal Reserve began its "tapering" program in December of 2013, when it announced that it would begin reducing the size of its monthly asset purchases by $10 billion. The Fed had been buying $85 billion worth of assets each month in an effort to keep interest rates low and spur economic growth. The tapering program was seen as a sign that the Fed believed the economy was improving and no longer needed such aggressive stimulus measures.