Uncertainty about the Fed is making stocks nervous and is adding to a growing bearishness about the market.
"Today you had a little bit more concern about what the Fed might do, so that's weighing broadly across the stock market," said Jeff Kleintop, chief market strategist at LPL Financial.
In the quiet August market, investors are looking ahead to the unknowns that are coming with September. The big event is the Fed's Sept. 17 and 18 meeting, where it is expected to determine whether it has enough information on the economy to begin paring back its bond buying program.
Stronger economic data and the idea that the Fed will slow down its $85 billion in monthly bond purchases has sent rates higher, with the 10-year yielding 2.72 percent Wednesday, just under its recent high. The Dow was off 113 at 15,337, and the S&P 500 was off 8 at 1685.
"The bond market priced in the taper. The equity market has not, and now it's beginning to," said Peter Boockvar, chief market analyst with Lindsey Group.
Kleintop also believes stocks are beginning to price in the Fed's pullback. "It's a little bit of a buyers' strike ahead of the Fed," he said, adding when the Fed does say it will act, stocks could sell off. "It depends how much we react ahead of time. I do think it's a five to 10 percent move in the stock market to the downside…it's not just about the Fed. It's the fact we're also going to get into the debt ceiling debate, just as Congress gets back."
Bespoke Investment Group released an investor survey that showed a growing bearishness among institutions. Of the 186 individual investors, 51 percent saw the stock market higher in a month from now, while just 26 percent of the 46 institutional investors surveyed shared that view.
"What people are kind of doing is they're taking time to take positions to prepare for next month," said Marc Chandler, chief currency strategist at Brown Brothers Harriman. "I think people are reluctant to take big positions right now. They're more likely to lighten up on risk."
Since the Fed's trigger will be better economic news, the market has become hyper-sensitive to every bit of data, and Thursday's weekly jobless claims will be an important glimpse at the job market, ahead of the Sept. 6 August employment report. That employment report is viewed as the most important tell for the Fed ahead of the September meeting.
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"The prior week will be revised higher, because that's what it's been doing, but the number should stay below 350,000. Sub 340,000, if it works out that way, would be even better," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. That number is low enough to signal continued improvement in the job market.
Stocks have also had a mixed reaction to good news, as the Fed decision looms over the market. "Claims have been trending down which gives license to the Fed to back off," said Boockvar. "There's every reason for them to pare back and we should get more confirmation of it now."
Thursday has a busy economic calendar with the weekly claims, CPI consumer inflation data and the Empire State survey, all at 8:30 a.m. ET. Treasury international capital flows data is released at 9 a.m., and industrial production is at 9:15 a.m. The Philadelphia Fed issues its monthly survey at 10 a.m., and the National Association of Home Builders survey is released at the same time.
Also big on the calendar is Wal-Mart earnings, an important window on consumers. Earnings are also expected from Estee Lauder, Kohl's, Perrigo, and Briggs and Stratton before the bell. Applied Materials and Nordstrom report after the close.
St. Louis Fed President James Bullard, speaks at 8:15 a.m. for the third time in two days . His topic is the economy and monetary policy. Bullard Wednesday echoed the comments that came Tuesday from Atlanta Fed President Dennis Lockhart, who said the Fed may not have enough data by the September meeting to decide on tapering.
"He was actually saying what he said on Aug. 2., that the Fed needs more information before it acts. The problem is if they are looking for the perfect information, they're never going to find it," Boockvar said. Unlike Lockhart, Bullard is a voting member of the Fed.
The talk now has become that the Fed could do a smaller amount of tapering, like trim the program by $10 billion a month instead of $20 billion.
"Markets are very thin. It's making people nervous. It doesn't take much to move things around," said Steve Massocca of Wedbush Securities. "I really don't think it means much unless (the S&P 500) breaks through 1676/1675, even break 1680. I think we're in a trading range between 1675 and 1709."
Also up in the air is who will run the Fed in January, after Fed Chairman Ben Bernanke steps down. The known candidates are Fed Vice Chair Janet Yellen, former Treasury Secretary Larry Summers and former Fed Gov. Donald Kohn. President Obama is expected to make a choice in the fall.
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Nomura Americas Treasury strategist George Goncalves surveyed investors on who should run the Fed and how markets could react to the candidates. A slim majority – 52.7 percent now expect Yellen to be named. Summers was expected to be named by 36.4 percent and 10.9 percent said someone else would be chairman.
The majority of investors, 55 percent, expect a September announcement.
Yellen was viewed as bearish for the dollar relative to G10 currencies, with 46.3 expecting a bearish response and 34.7 expecting a limited reaction. Summers, however, was seen as dollar bullish, with 61.1 percent sharing that view.
If Yellen were named, 54 percent expect to see a slightly bullish impact on rates, compared to 68 percent if Summers were nominated. The stock market would benefit from a continuity of the Fed easing bias, if Yellen were to be named, according to 65.6 percent. Summers would be negative for stocks, according to 50 percent of the participants while 27.8 percent expected no material impact.
—By CNBC's Patti Domm. Follow here on Twitter