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"In August, the spring has been coiling, and in September the spring explodes," said Marc Chandler, chief currency strategist at Brown Brothers Harriman. "What people are kind of doing is taking positions to prepare for next month."
The first big hurdle for markets is the August employment report, on Sept. 6, a report that could dictate the Fed's decision on whether it will announce a reduction in quantitative easing. Economists are divided on when the Fed will start to pare down QE—its $85-billion-a-month bond purchases—but some believe it will be September.
"People are reluctant to take big positions right now. They're more likely to lighten more risk," Chandler said. "Take your summer vacation because after Labor Day, it ends very quickly."
But September will also bring clarity to an issue of major concern to the markets for the past several months, and that is when exactly the Fed will begin slowing its bond purchases, something it has said it hopes to do by year end. The Fed meets Sept. 17-18, so volatility is expected to increase around that event.
"The main source of uncertainty since May has been, 'Is the Fed going to taper?' " said Binky Chadha, Deutsche Bank chief global strategist and head of asset allocation. "Uncertainty should be resolved. We think they're going to do it. You're going to see some uncertainty leaving."
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September markets also have history against them, with the Dow down 60 percent of the time since 1950. "September is usually not a good month for equities, so there are the seasonal issues. Given the volatility in the first half, net net, September is not going to be great, but October, November and December should be good," he said.
Bond yields have been moving higher ahead of the Fed's September meeting, and just as there is disagreement in the market about when the Fed will taper, there's a range of opinions on how much it will reduce its bond purchases. Fed officials have said they would like to begin cutting back on purchases before year end and complete bond buying by the middle of next year.
"I suspect that we're going to grind a little bit lower from these levels into the September employment report," said Ian Lyngen, senior Treasury strategist at CRT Capital. "All the anecdotes suggest we'll get an 'at trend' or 'slightly better-than-trend' employment report. Then we'll commence the process of pricing in a tapering down, and that will push 10-year yields back to or above 3 percent. That's predicated on the fact that nonfarm payrolls are strong enough and no one can predict that number." The 10-year yield was at 2.79 on Monday.
Lyngen expects to see the Fed cut back $5 billion of its $40 billion in monthly mortgage purchases, and $10 billion from its Treasury purchases. Others expect the Fed to pare back as little as $10 billion in total and as much as $25 billion in the first move to cut back.
"We do think they are going to start tapering," said Bruce Kasman, chief economist at J.P. Morgan. "This is going to be a slow process. There's still an open question of whether they do it symmetrically, pulling down Treasury and MBS (mortgage-backed securities) equally. We think it could be only Treasurys." Kasman expects the Fed to cut out $15 billion to $25 billion in Treasury purchases in the first round.
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Kasman said the Fed will also be looking at its 2016 forecast at the September meeting, an event that in itself could bring some volatility to rates. "We think we'll see them forecasting an economy that's close to full employment at the end of 2016," he said.
The market, however, is not forecasting normalized short-term rates by then—which would be more likely 4.25 to 4.5 percent, if the economy is at full employment, said Chadha. "The market pricing of the Fed funds rate is like 75 or 100 basis points by March 2016, and that would be basically off by 350 basis points. That is a huge challenge. That's one of the reasons I believe there will be this volatility," he said.
Fed Chairman Ben Bernanke holds a briefing after the September Fed meeting, his second-to-last post-FOMC briefing before his expected retirement at year end. The market focus on his replacement has already added volatility. Traders say an appointment of former Treasury Secretary Larry Summers would mean higher rates and be a minus for stocks since he is seen as less dovish than Fed insider Vice Chairwoman Janet Yellen.
"It's one of the most ferocious fights I've seen in my career. I think people at the Fed adore Janet Yellen and they have great respect for her intellect, and they're rooting for her, but Barack Obama has been through the wars with Larry Summers and he's comfortable with Larry Summers," said Greg Valliere, chief political strategist at Potomac Research. "I think there will be a calculation at the White House soon that a confirmation hearing on Larry Summers would be a train wreck."
The White House is already gearing up for a battle with House Republicans on the budget this fall. "Yellen would sail through. Does the White House want another big fight by nominating Summers and angering Democrats? I think the prospect of a really ugly conformation fight could tip the balance in favor of Yellen," he said.