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Why bonds may rally for a long time

Talking Numbers

While the world focuses on Janet Yellen, who was sworn in on Monday as Federal Reserve Chair, one prominent fixed income analyst says it’s the other Fed members that traders need to watch.

Jennifer Vail is the Head of Fixed Income Research at US Bank Wealth Management, a firm with $115 billion in assets under management. She believes that the Fed will become less accommodative in 2014 due to a rotation in its voting members. Two new voting members, Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser, have been quite public about wanting a quicker end to the Fed's "quantitative easing" ("QE") monetary stimulus.

(Read: US bonds push lower ahead of more manufacturing data)

And, though the Fed has tapered QE down from $85 billion per month to $65 billion since December, bonds have done a curious thing: They've gone up when everyone expected them to go down.

"The last couple of weeks have been a bit more surprising," says Vail. Concerns about the taper, along with worries about Chinese growth and more local issues as well, has increased uncertainty in global markets. That uncertainty, in turn, has led to a flight to bonds, according to Vail.

"We believe it to be a short-term parking of assets that are under concern while we go through this volatility in the emerging markets," says Vail.

And, that flight from US stocks and into the relative safety of US bonds may possibly have been a little too much given the relatively small exposure to emerging markets for US companies.
"We do believe there has been an overreaction both in the equity and in the bond markets," says Vail.

"Emerging markets certainly represents some diminished growth opportunity for the US but not to the extent that we see in the market move."

(Read: Market strategists: Don't overreact here)

Vail believes it will take another several weeks before the Fed can get a sense of what's ahead for the economy. While, Vail thinks everything will continue as is until then, things may change quickly.

"We wouldn't expect the Fed to take the foot off the taper gas pedal at this point," says Vail. But, she thinks better data will hasten more tapering. "We wouldn't be surprised if the economy continues to grow significantly, causing the Fed to actually accelerate the tapering program."

To see the entire interview with Jennifer Vail on what's next for bonds in this environment, watch the video above.

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