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As Fear Trade Unwinds, Unease Remains

Markets have been shaking off the worst of this summer’s fear trade, and now traders are looking for the next catalyst that will break the August doldrums.

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Stocks and interest rates are back to levels they were at in late spring, before the latest bout of euro-driven panic sent a shudder through markets and pushed interest rates to record lows. U.S. Treasurys were a safe-haven of choice as investors worried Spain, and then Italy would be engulfed by the spreading euro zone sovereign crisis this summer.

“It kind of feels like the Treasury market had a period of normalcy for one week. There was more supply to take down, less buyers and rates actually went higher. A bit of normalcy was introduced,” said Nomura Americas Treasury strategist George Goncalves. “The question is, is it here to stay, given all these unresolved issues out of Europe. It’s just like we had this window in time where auctions actually mattered and we end a cheapening in the bond market. It may be too good to be true. It may only last this week. It was kind of refreshing to see.”

Calm has taken hold in a low volume bond market. For instance, the $16 billion 30-year bond auction saw light demand Thursday, and a high yield of 2.825 percent, the highest level since late June. After the auction, rates were at 2.75 percent, well above late July’s 2.45 percent low. The 10-year tested a late May high yield (explain this) of 1.73 percent Thursday, before trading back down to 1.69 percent, a big move up from last week’s ranges and well above the July low of 1.38 percent.

The same market phenomena is showing up in stocks, where a rising stock market has pitted theS&P 500 against the key 1400 level, a zone it was last at in May. The index rose above the 1400 level Tuesday for the first time in three months, finishing at 1401, but it has only managed to hold slightly above it. On Thursday, it closed at 1402, gaining about a half a point on the day. Traders say the S&P needs to break out meaningfully above 1400 to confirm the move.

Some commodities have also returned to spring levels, with the Jefferies/Thomson Reuters CRB index of 17 commodities at a three-month high.

Analysts say last week’s promise of possible action by both the European Central Bank (explain this)and Federal Reserve(explain this) is behind the market moves, and is supporting risk assets. But traders say just as quickly, a negative headline could come from Europe and tip markets back into fear mode.

Traders also point to a myriad of worries for stocks, beyond Europe. The list includes weaker U.S. and Chinese growth; the uncertainty around the presidential election; the threat of the fiscal cliff’s double whammy of new taxes and spending cuts on Jan. 1, and the prospect of slowing corporate profits.

“The rally has gotten everybody bewildered,” said Art Cashin, director of floor operations at UBS.

“But I think everybody right now — bulls and bears — would like to tiptoe into the weekend and take another look next week,” he added.

The end of the month Fed symposium in Jackson Hole, Wyo., is the next big event that traders are watching. It was there two years ago that Fed Chairman Ben Bernanke signaled a round of quantitative easing (explain this), or Fed asset purchases. The speculation is that he could do something similar this year, clearing the way for the Fed to take action in September.

Comments last week from ECB President Mario Draghi, promising action to defend the euro, also have markets expecting some move from Europe’s central bank in the September period.

“It’s been quiet for the past few days … It’s kind of the dog days of summer,” said Jeff Kleintop, chief investment strategist at LPL Financial.

Kleintop said the calm is probably temporary.

“I do think we’ll see some volatility come back," he said. "It wouldn’t surprise me to see stocks move back to the bottom of this channel we’ve been in. September is a big month for declines, but August is a big month for volatility.”

As for Treasurys, Goncalves said the auctions could have set the highs in yields for now.

“It might be tranquil into these key events, at the end of August and into September, then we’ll reassess the rest of the year,” he said, adding that Germany votes on the ESM bailout mechanism and the ECB meets in early September. The Fed meets Sept. 12.

What to Watch

Friday’s markets have several earnings and some data. Import prices are released at 8:30 a.m. EST, as is the U.S. Department of Agriculture’s major crop report, which should give new details on the state of the drought-stricken corn and soy bean crops. New corn crop (December) futures closed at a record $8.23 a bushel Thursday.

On Friday, JC Penney and Brookfield Asset Managementreport earnings before the opening bell.

Follow Patti Domm on Twitter: @pattidommQuestions? Comments? Email us at marketinsider@cnbc.com

  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

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