Fixed Income 2013

Best bond plays regardless of taper timing

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The Federal Reserve isn't slowing its bond buying just yet, but the timing of the taper doesn't matter, and there are still smart plays for bond investors regardless of exactly when tapering finally begins, according to one analyst.

"The key here is we know where our starting point is. Today the Fed is buying about $85 billion worth of bonds a month. We know where our ending point is. By mid-2014 they plan on buying zero dollars of bonds per month. So if you take that start and that end, it really doesn't matter all that much whether they start reducing ... purchases in September at a slow pace or purchases in November at a little bit of a faster pace," said Guy LeBas, fixed income strategist at Janney Montgomery Scott.

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"Timing matters, but it's the magnitude of the taper that matters more than the timing," said Diane Swonk, chief economist at Mesirow Financial, who still expects the taper to be gradual. "It's clear that they don't want to go back in and raise purchases after the taper has begun," Swonk added.

While the labor market has improved, the unemployment rate is still high. And while the housing market has strengthened, mortgage rates are up and fiscal policy is restraining economic growth, the Fed said in a statement after its meeting Wednesday.

Santelli's morning bond update
Santelli's morning bond update

"The [Federal Open Market] Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market," according to the Fed statement.

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"Because of the volatility that's entered into the markets recently, it's our recommendation that investors look to shorten up and take a look at some of those sort of safe-haven shorter-term areas in the bond markets," LeBas said.

And regardless when the Fed tapers its bond buying, bond duration is the key metric for investors, said LeBas, who adds that three-year corporate bonds in particular are the best bet.

"Duration is a simple measure that relates essentially the volatility and market price of a bond that changes with interest rates. Bonds with longer durations, for example longer maturity dates, tend to be more sensitive to swings in interest rates," LeBas explained.

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"Status quo Fed policy was a warning shot to the bond market," Swonk said. "The long-term rally in bonds may be coming to a close, but it's going to be a very slow close."

—Althea Chang, Producer