The market Monday closed higher with the Dow up 65 points to 14,974, but still 109 points below its high for the day. The S&P 500 also backtracked, and traders said the trading tone changed when it failed to hold above its 50-day moving average at 1624. The S&P ended up 8 at 1614. The 10-year yield was at 2.48 percent late in the day, below the 2.5 percent level where stocks seem to get more nervous.
"I think it's obviously always good when the market starts off with a positive note, and I think the right groups are leading today," said J.P. Morgan U.S. equity strategist Thomas Lee. Cyclically sensitive sectors, led by top performers industrials, materials, tech and energy, were the best performers of the day, with the only losing sectors, defensive utilities and telecom.
"I feel confident and our economists feel confident with the fact that growth should improve in the second half, largely because drags are fading. We're going to see better support from housing, as well as autos in the second half. I think the economy is building some momentum," said Lee. "The biggest overhang still is some of the spillover and repercussions from the selloff in fixed income. I think that we've also had, because of rising rates, essentially a form of credit tightening taking place in the market. We're going to feel some of the ramifications of that." Lee expects the S&P to hit 1715 by year end.
A widely held view on Wall Street this year has been that the economy would pick up in the second half and accelerate into 2014. Economists, however, are divided on whether growth will really accelerate or just chug along at a 2 percent rate for the next six months.
"The economy is expected to reaccelerate but from what? The current quarter looks like 1.5 from 1.8 in the first. That's not really great," said Diane Swonk, chief economist at Mesirow Financial.
The Fed also sees acceleration, but it has confused the picture with talk about reducing its bond purchases. A swarm of Fed speakers has tried to clarify what the Fed is doing in speech after speech last week. New York Fed President William Dudley speaks again Tuesday at 12:30 p.m. ET at a Connecticut business council on the regional and national economy.
"Team Fed comes out to support the idea that they're not going anywhere anytime soon," said Swonk. "Bottom line, mea culpa. They're eating crow and the Fed is doing everything it can do to stop the damage."
(Read More: Fed Tapering: It's About Time!)
She said one problem is that the Fed did not put an end date on its last round of quantitative easing, as it had in the past. "It underscores the limits of an open-ended policy. I just do think communicating that is very difficult. It may look great in theory but we're actually in a real-time experiment with monetary policy," said Swonk.
After its June meeting, the Fed indicated it would slow down its quantitative easing program, or QE, sometime this year and it could stop buying bonds by mid-2014 if the economy improves. That launched a wave of selling in credit markets, as market players rushed to the exits, dumping not just bonds but stocks and other assets, ahead of rising rates. The Fed's comments also sparked a rapid move up in Treasury yields that were already beginning to move higher on better-looking economic data. The 10-year yield last week reached a high of 2.66 percent, up sharply from its low of 1.62 percent in early May.
In an unusually coordinated commentary, the more than half dozen Fed officials emphasized that the Fed is nowhere near ready to raise short-term rates, and that its decision to "taper" its bond purchases will be dependent on the economy improving, not a timetable. They also more than once noted that the markets had overreacted.
"The markets just can't handle this much information," said Swonk, noting the Fed's message was too complicated.
Helped by the Fed speakers, the bond market stabilized last week, equities went higher, and yields steadied but the damage was done. Mortgage rates jumped, with the 30-year fixed rate rising to 4.46 percent last week, up from 3.93 percent the week earlier, in the biggest one-week rise since 1987.
Under QE, the Fed is currently buying $85 billion in bonds each month, $40 billion of which are mortgages and the balance, Treasurys.
(Read More: Why Bond Selling Hysteria Is Overdone)
"A month ago, I would have said I think the American economy is going to strengthen in the second half of the year. It's become a more difficult question. What makes it more difficult has been the incredible spike in mortgage rates," said Richard Bernstein, CEO of Richard Bernstein Capital Management.
"Mortgage rates are up 120 basis points since the beginning of May. Even though they are extremely low, they are extremely low on an absolute basis, and it has to affect the marginal borrower."
Housing has been one of the engines of the economy this year, after slowly climbing out of years of crisis and paralysis. The Fed's easing policy has clearly been a positive influence on lending rates, and real estate prices are rising as sales pick up. Pending home sales in May were up more than 12 percent from year ago levels, and are currently at a six-year high. Actual sales of existing homes in May rose 12.9 percent above last year's level to an annual rate of 5.18 million, the best since November 2009.
Deutsche Bank's chief U.S. economist, Joseph LaVorgna, said housing is one bright spot that makes him optimistic the economy will start to grow faster.
"Housing is turning and the housing share of the economy has come a long way and still has a ways to go as far as getting back to an equilibrium level," said LaVorgna. "The housing market is telling me that growth should be better in the second half."
LaVorgna said this year the economy is far better off than last year when the Fed began a new round of asset purchases. He expects second-quarter growth of 2.3 percent, after the economy grew at a revised 1.8 percent annualized rate in the first quarter.
(Read More: Fed Speak Could Shape Trading Day)
For the third quarter, he sees the economy growing by 3 percent, and 3.5 percent for the fourth quarter. The Fed's forecast is for GDP growth for the year of 2.3 to 2.6 percent, and for 3.0 to 3.5 percent in 2014.
Some economists see those forecasts as too rosy.
"We're still looking for 1.5 percent real GDP growth in the second quarter," said Dean Maki, chief U.S. economist at Barclays.
"We think growth will remain modest in the second half. We're looking for 2 percent growth in Q3 and Q4. We have quite a different view than the Fed, which is looking for 3 percent growth in the second half. We think a key reason for this is the sequestration cuts are still to occur. For example, the defense furloughs don't even start until July. We think the second half will be weighed down by the budget decline."