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Why tapering will actually boost bonds: Pro

Jeff Kilburg, CEO and founder of KKM Financial
Wednesday, 18 Sep 2013 | 11:22 AM ET
Traders work in the VIX pit at the Chicago Board Options Exchange in Chicago.
Getty Images
Traders work in the VIX pit at the Chicago Board Options Exchange in Chicago.

As we anxiously await the Fed's imminent decision, the bond market fluctuates, and the 10-year note is yielding 2.89 percent (Rick Santelli's line in the sand).

Sunday's bombshell announcement that Larry Summers was no longer seeking the Federal Reserve chairmanship candidacy launched investors back into Treasurys. On Monday, we experienced one of the most precipitous drops in Treasury yields thus far in 2013, as the market believes that the QE program will not be wrapped up as quickly without Summers at the helm.

This move—which was nicknamed the "Summers slam" in the bond pits in Chicago—certainly caught some shorts in the bond market.

Janet Yellen, the vice chairwoman of the Fed Board of Governors, is now the most likely nominee. And when Ben Bernanke steps down, a Yellen appointment will probably make for a much smoother passing of the baton.

So counterintuitively, Bernanke is now in the position to taper a bit more rather than less, because the QE program will probably be around a bit longer under Yellen's leadership, compared with under Summers'.

(Read more: Whatever the Fed does, gold will rally: Schiff)

Will taper actually boost bonds?
Have bonds priced in tapering? Where are yields headed? The Fed and the bond trade, with CNBC's Mandy Drury and the Futures Now Traders.

So will the Fed taper? In my view, yes. It is likely that the Fed will announce a $15 billion to $20 billion monthly reduction of the stimulus program. But this won't actually make bonds drop as many expect. In fact, it will actually put a bid into the Treasury market.

Psychologically, a $15 billion to $20 billion taper will make investors rethink the "risk-free" trade of piling into equities. And the money flowing out of equities will head into the safe haven of Treasurys.

(Read more: If the Fed tapers, here's how far stocks will drop)

So while Bernanke is running out of tools, tapering would actually push folks back into Treasurys, and keep yields below 3 percent on the 10 year. This is crucial for the Fed, because it wants to be careful not to negate its achievements (like the housing and banking recovery) by allowing rates to tick too high, too fast. But that's just what yields have done recently.

The Fed, then, will taper its QE program. And the 10-year yield will stay closer to 2.5 percent as this policy change is digested.

By Jeff Kilburg, CEO and founder of KKM Financial. Follow him on Twitter @TheKillir

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