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Anxious bond investors start to look beyond the taper

Most investors are split on whether the Fed will announce a reduction in its $85 billion monthly bond-buying program on Wednesday or in the first quarter of 2014. But some are starting to argue that the bond market is already looking beyond the first reduction, or tapering, and onto the future of quantitative easing.

"The market is anticipating a taper, and whether it's tomorrow, whether it's January or March, the process has begun," said Peter Boockvar, chief market strategist at the Lindsey Group. "So investors need to take the analysis one step further, and see whether the Fed is looking at this as a one-and-done ... or if this is the beginning of the end" of QE.

The market last predicted a taper in September, on the strength of guidance from Fed Chairman Ben Bernanke. But partially due to threats of a government shutdown and U.S. debt default, Bernanke decided to hold off. Boockvar says the bond market is once again geared up for a tapering announcement.

"The bond market, at a 2.85 yield [on the 10-year note] is back where it was a day before the Fed chose not to taper, therefore implying that the Fed has teed up the market—or the market has teed up the Fed—in anticipation of an eventual taper," Boockvar said. "So in the market's eyes, it's a matter of when, not if."

(Read more: Treasurys edge higher ahead of Fed meeting)

Lawrence McDonald, U.S. credit, equity and policy strategist at Newedge, goes one step further. He makes the point that if the bond market focused solely on tapering, yields would be higher still.

"Based on strong economic data, the 10-year yield should be at 3 percent," McDonald said.

But as he sees it, the bond market is looking beyond the beginning of the taper and paying attention to actions the Fed could take to calm the market in the case of a $10 billion or so reduction in asset purchases.

"There are two new weapons behind the scenes," said McDonald, who writes at LawrenceGMcDonald.com. "One is the unemployment threshold being lowered from 6.5 percent down to 6, maybe 5.75 percent, which would be massively dovish. Secondly, I think they're going to drop a bomb in the next two to three months and start to invoke a 1 percent inflation floor."

Traders work in the S&P 500 options pit at the Chicago Board Options Exchange
Getty Images
Traders work in the S&P 500 options pit at the Chicago Board Options Exchange

A lower threshold or a floor on inflation would "open up a whole new world," he told CNBC.com. "The problem with the taper is that the entire Street all says that the Fed will be done by the end of the year. But if you bring in this element of the inflation floor, that means it could take them a year and a half to unwind."

(Read more: BlackRock bond guru: Now I prefer stocks to bonds)

On the other hand, Kathy Lien considers the bond market's attempts to look beyond the start of tapering a bit silly.

"I don't think traders have a good sense of the pace" at which the Fed will roll down QE, said Lien, managing director of FX strategy for BK Asset Management. "And that's simply because the Fed themselves don't have a good sense of the pace and when the program will end."

—By CNBC's Alex Rosenberg.

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