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Dissent in the Fed good for bond markets

02/25/2013 | 01:30pm US/Eastern
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ANCHOR (OFF-CAMERA) ENGLISH SAYING:

Well, you know, after the Fed's comments a couple of days ago, there seemed to be some thought that some people in the Fed aren't exactly happy with what's happening with QE. And so there is a lot of speculation about what happens next. Let me ask you, as somebody who's managing fixed income portfolios, does this concern you at all - some of this dissention if you will?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

I think it's actually very healthy for the markets. What we've been seeing is risk assets, particularly credit, grind tighter and tighter and it's really technically or liquidity driven. And the fundamentals, while I think they're positive, they're very slow to emerge. And the risk in Washington is still hanging over the markets. So I really view the Fed's message, that discourse, to really relieve a little of that steam and bring a little bit more value to the market. I thought it was a good move.

ANCHOR (OFF-CAMERA) ENGLISH SAYING:

Do you worry about a bond bubble?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

I think that interest rates are going up. We don't know when but we know they're going up at some point and that's going to impact the markets, in particular the riskier markets because people believe they're taking credit risk which you would want to do in this environment, but really a lot of those areas have become much more interest rate sensitive. And the high yield market is an excellent example of that.

ANCHOR (OFF-CAMERA) ENGLISH SAYING:

So what do you see happening in that market?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

You see investors really chasing yield and bidding up bonds, and it's creating a market that I think is pretty frothy. You can just sense that something has to give; I don't know when but it's going to give, and I think in a big way.

ANCHOR (OFF-CAMERA) ENGLISH SAYING:

How about where your expertise lies - investment grade - is it the same picture there or do you think it's more fairly valued?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

Well, investment grade is a challenge in its own right in that it typically, because there's less credit there, it is more interest rate sensitive. And when you think about where rates are headed, just doing the math, you're looking at returns that are not too attractive. Definitely don't want to be in treasuries but investment grade credit is challenge I think to provide good returns.

ANCHOR (OFF-CAMERA) ENGLISH SAYING:

Over the next couple of days, perhaps beyond, we'll be hearing a lot more about the sequestration deadline. How do you make your moves in the bond market in light of what's happening out in Washington? Or should you just do this and stay away when it's over; I'll be fine?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

That might be the best strategy. We all know it's coming, not really certain of what the outcome is going to be. I'm somewhat optimistic in that, with politicians, they care about career risk. They'd like to keep their jobs. And I think we know that there's going to be some impact on the economy. The Fed will be there to support it. So any blips in the market I would view as an opportunity. But let's just get through this. And if we remove that one risk of uncertainty, there's a lot of cash on the sidelines that would just come roaring into the market.

ANCHOR (OFF-CAMERA) ENGLISH SAYING:

Well, where is the best opportunity because you've raised some issues about where it's looking frothy or not so attractive? So where in fixed income is the place to go?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

Excellent question because it's hard to find the exact value. Looking at just levels overall, there's not a lot of value. So you have to think differently which means lengthen your time horizon, find opportunities where it's a turnaround of some sort that's going to take time, and the answer is it's less about interest rates and more about company fundamentals. So some of the M&A activity that we're seeing I think is presenting some good opportunities. We're seeing fallen angels. Not every one of them is going to be a good investment. But it's shaking up the market a bit and that's where you find good longer term investments.

ANCHOR (OFF-CAMERA) ENGLISH SAYING:

I want to end on the Fed since we began there. What about TIPS? Should people be thinking about them?

KATHLEEN GAFFNEY, VP, EATON VANCE (ENGLISH) SAYING:

I think what they need to keep in mind with TIPS is that they'll do better than treasuries, but when rates start moving, the 10-year goes up 100 basis points, you're looking at close to double digit negative returns, a -7% to -9%. TIPS will do better but you're still looking at negative returns. I'd avoid.

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