The May employment report is being dubbed the most important in years, with the power to shape market expectations for weeks, if not months to come.
Interest rates have moved higher ahead of it, stocks have traded anxiously for several weeks, and Fed officials have fanned expectations that they are getting ready to consider downsizing their $85 billion a month in bond purchases. The 30-year mortgage has even crept above 4 percent for the first time in a year last week.
But there's also a good chance the May report, expected to show 170,000 nonfarm payrolls, simply just shows just that – a status quo of sluggish jobs growth, much like last month. It also may do little to clarify the Fed's next policy move, as markets had been hoping.
"In this recovery, this (jobs report) seems to be the one that's getting the most attention," said Dean Maki, chief U.S. economist at Barclays. "We think it's going to be another moderate growth report. Another moderate gain in jobs, so we're looking or 175,000 headline payroll gain. The unemployment rate we do expect to tick down to 7.4 percent."
(Read More: Progress on the Job Front Will Be Slow)
"I think this will be seen as a report that's not convincing either way in terms of tapering," said Maki, who expects the Fed to begin tapering next year. Fed officials,including Fed Chairman Ben Bernanke, have said that the Fed could start to reduce their bond purchases in the next several months if employment is strong enough, and the street is beginning to move toward that view.
"We think not until March of 2014. Our view is that the labor market and GDP will be slow enough that the Fed decides it's not worth tapering at this point…and it's because we do not expect the bounce back to 3 percent (GDP growth) that they are expecting," Maki said. "The bond market seems to have been pricing in a more hawkish Fed, rather than a stronger economy."
During Wednesday's trading, whisper numbers flew around the street – some were in the 150,000 range and others were much lower, but traders had varying views on how the markets would react to an 'in line' number, versus one that was much stronger or weaker than expected. A stronger number in theory should be a positive for stocks, as it signals a stronger economy, and it would be a negative for bonds, driving rates higher.
But some traders expect a weak number to be positive for stocks, since it would mean the Fed would continue its quantitative easing program at full throttle, and the program is seen as a positive for risk assets. Bonds,in theory would react positively, and rates should decline.
"The market has priced in a weaker than expected number," said Deutsche Bank chief U.S. economist Joseph LaVorgna. "I would argue anything between 100,000 to 160,000 is kind of expected. You need something well under 100,000 or something well above 160,000 for the market to catch it as a surprise. If it's better, the fixed income market sells off. If it's weaker, the fixed income market rallies but then you have supply next week. Yields are going up regardless of the what the number looks like tomorrow."
Markets have been much more volatile in the last several weeks, as Fed speakers have discussed their views on the pullback from quantitative easing. This talk has dominated markets against the back drop of a major selloff in Japanese stocks on unease about Japan's major easing and stimulus programs.
Interest rate sensitive assets have sold off, and the markets are struggling to determine whether rates are now in a rising trend or are just temporarily higher. Dallas Fed President Richard Fisher, who is not a voting member of the Fed, surprised traders this week by saying the rally in bonds is over.
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For the week ending Wednesday, Lipper reports that fixed income funds saw outflows of $9.1 billion net, the second largest amount since it began tracking weekly flows in 1992. Stock funds saw a second week of outflows, totaling $2.3 billion.
Thursday's trading had its convulsive moments. The yen rose sharply, unraveling a whole world of trades that were tied to yen shorts.Treasury yields swung lower, stocks fell sharply and emerging market yields widened.
(Read More: Yen Rally Sends Shock and Selling Through Markets)
"It was utterly wild," said CRT Capital Chief Treasury strategist David Ader, describing a roller coaster ride in the yield on the 10-year note. "We opened about 2.09, a little better than yesterday, and we had a move in a space of five minutes going from 2.06, 2.05 to under 2 percent…It was a very fast, short lived move. It was inspired by equities, inspired by the yen and inspired a lot by mortgages."
After a triple digit swoon into negative territory, the Dow closed higher, up 80 at 15,040, and the S&P 500 rose to 1622, up 13, recovering after slipping beneath its 50-day moving average at 1605, and bouncing off support in the 1598 area.
Ader said the Treasury market ultimately signals the expectation is for a weak jobs report. "Uncertainty is not something the markets deal with, and they (the Fed) took a central bank approach, and not a market approach," he said. Ader said the Fed may have boxed itself in, creating a market that will now not easily let go of quantitative easing.
"What's going to be the easiest way to get the patient off this drug? Is it cold turkey or is it methadone?" he asked. "Today's action reveals we don't know how to handle this."
Mesirow Financial economist Diane Swonk said its possible the Fed could start to pare back bond purchases starting in September, but she also does not see a growth outlook as rosy as the Fed or some other economists for the second half of the year. "I think the issue is we haven't seen the full effects of the sequester and people have gotten this false sense of security that it's not out there, and the reality is it is out there," she said. "There's going to be job reductions. Some government employment is going to be reduced."
Maki also believes the full impact of the sequester, or automatic spending cuts, have not been felt and he is expecting growth of just two percent for the second half. LaVorgna, however, expects the Fed to taper in September, and he sees the economy improving from the current sluggish sub-2 percent growth in the second quarter.
"The economy is fundamentally healthy. The building blocks for continued growth are there, and that's why the second half of the year should be better," he said. "I think we finally get to the promised land of 3 percent growth." But he expects May's jobs report to be weaker than consensus, at just 125,000, and he notes May has been especially weak for the last several years.
Swonk expects to see 140,000 nonfarm payrolls, and she said the number has become overly important to markets. "In the near term, it will shape market expectations because it's gotten this out-sized weighting and that's unfortunate because the reality is they are taking everything into account. It's not just one number. It's not just one month. The market likes to distill it down to simplicity," she said.
Swonk said the markets have been impacted by uncertainty, due to the dissonance within the Fed, with some officials saying bond purchases should be wound down now and others saying several months of confirming economic data are necessary.
"They're all singing in the chorus about how they don't like fiscal drag…they've all come pretty much in line about that issue. The dissonance is about timing issues and that's what they're going to have to come to consensus on, and most of them thinking it would be nice not to have this much longer. The earliest is September and it's still just calibrating."
Credit Suisse economist Jonathan Basile expects to see 150,000 jobs added in May, and he said if that is the number, the Fed will still talk about tapering since clearly some officials favor it sooner rather than later. "We have to think about what they're tapering. Is it MBS (mortgage-backed securities).Is it Treasurys? Is it both? Does the housing market really need the MBS purchases to receive support. Look what's happening to housing. You have more buyers than sellers and prices are going up. Do the training wheels still need to be on the housing market…with the Fed's MBS purchases?"
Basile said Credit Suisse expects to see tapering, starting in September, with the Fed paring back its purchases of Treasurys to $35 billion and its mortgage purchases to $30 billion a month. Even with tapering, the Fed still has a hefty easing program underway and has more than $3 trillion in securities already on its balance sheet.
But Basile's questions about mortgage-backed purchases highlight an issue on Wall Street, and that is there is little consensus about what the Fed intends to do and what it means for market pricing.
CRT's Ader surveyed market participants Thursday and found they are unclear about what the Fed might do. He said a majority believes the Fed will cut back on Treasury purchases and mortgage purchases equally, but a good number believe it could cut back just on Treasurys and others see it ending just mortgage purchases.
Ader's survey also showed that 76 percent believed tapering would begin this year, but most did not expect it before September. A third thought it would begin in either September or October. "The market is confused in here," he said.