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A Word About Skittish Markets

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Prepping for co-host slot on CNBC's Squawk Box tomorrow, and scratching the old bean a bit re stock market volatility of late. Along with the general nervousness about earnings in a climate of some uncertainty re growth (Asia, Europe, even here), there's this extra layer of anxiety around the Fed and interest rates.

MarketWatch re: today's losses:

U.S. stocks fell...[with the Dow off 76 points, or 0.5 percent]...as Wall Street remained on alert for clues as to central-bank policy moves ahead.

"The past few weeks have been all about whether the taper is going to occur or not, and what that means," Nick Raich, CEO of the Earnings Scout, said of the heightened volatility that has come with uncertainty as to whether the Federal Reserve would curb its $85 billion in monthly bond purchases sooner than anticipated.

The Chicago Board Options Exchange Volatility Index... is up 30 percent in the last month, and 15 percent in the last week, and that's because of the tapering concern, said Raich. [see figure below]

First off, in case you've missed it, "taper" is the new "tighten," though the word change is substantive in a way that I think is important as to what's going on here. The Fed is acutely aware that they're supporting stock and other asset prices right now and they're even more acutely aware that markets are on tenterhooks as to when and how they're going to turn.

And since the last thing they want is to is disrupt the markets, they will continue to operate with unprecedented transparency and extremely gradual movements. Once it starts, the "unwind" will occur slowly and carefully. They won't take away the punch bowl. They'll start by pouring a bit less punch in, and when they're ready to cut the juice, it will be with a straw, not a ladle.

Second, whadya mean, "whether the taper's going to occur?" Of course it will. The Fed's balance sheet is almost four times what it was before the crisis ($3.4 trillion now vs. under $900 billion in 2007). Interest rates must rise. The must rise as the economy improves, as lenders seek higher returns and hedge against inflation, and they must rise at the Fed as they (slowly... very slowly) unwind their bloated portfolio and break free of the zero lower bound on nominal rates.

I'm not managing a zillion bucks in a hedge fund, so it's easy for me to say, but it's the stock market, not a romantic comedy. You gotta take the ups with the downs. The Fed undertook unusual measures to boost the markets and as the economy recovers, they must pull back. They can't give us the precise date -- they've already told us about their unemployment and inflation triggers (6.5 percent and 2.5 percent, respectively) -- and I expect them to continue to provide extensive "forward guidance."

(Though it is unfortunate when Fed governors go about making confusing noises about this. Even here, however, you have to breathe deeply and listen carefully. Fed governor Esther George spooked a lot of people with remarks released yesterday, but re: the taper, she's hardly saying anything different from the above.)

Nervousness spreads in markets like this one and I doubt cooler heads will give the Fed the benefit of the doubt. Every utterance by every governor will be scrutinized for the "whens" and "how much's" of the taper. But unless you get off (or make money) on volatility, I'd ride this one out until the anxiety market settles down a bit.

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Source: MarketWatch

This post originally appeared at Jared Bernstein's On The Economy blog.