Markets Still Waiting for Breakthrough on 'Fiscal Cliff'

Stocks traded uneasily after President Barack Obama and House Speaker John Boehner Friday each voiced willingness to compromise heading into difficult "fiscal cliff" negotiations.

Markets Still Waiting for Breakthrough on 'Fiscal Cliff'
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Both held out a spirit of cooperation, and Obama invited Congressional leaders to the White House next week to begin discussions on economic and fiscal issues. (Read More: Obama 'Open to New Ideas' But Rich Must Pay More)

"While Boehner was speaking, the market traded rather nervously and in fact gave up small ground. When the president came out to speak the market again went nervous and gave up half its gain," said Art Cashin, director of floor operations at UBS.

The S&P 500 was up more than 1 percent before the president took to the podium just after 1 p.m. ET, but it moved lower and was up just slightly in mid afternoon trading. (Read More: Market Pares Gains on Obama Remarks)

Obama repeated that the approach to fiscal problems must be balanced and include both revenues and spending cuts, but he signalled he is willing to compromise. Stocks appeared to take a leg down when Obama suggested, as a starting point, that the House pass a Senate bill that would restore the Bush tax cuts to the middle class but not the upper income brackets.

"I'm open to compromise. I'm open to new ideas," Obama said. "But I refuse to accept any approach that isn't balanced. I'm not going to ask students and seniors and middle class families to pay down the entire deficit while people like me making over $250,000 aren't asked to pay a dime more in taxes."

House Speaker John Boehner, in a press conference Friday, said he is "hopeful' that a deal can be reached. He repeated his willingness to raise revenues but still opposed returning to higher tax rates for the richest Americans.

"What the market does not want to hear is that people decided to fold their arms and there is a line in the sand. One is using the word rates and one is using the word revenue and that can find a common ground," said Cashin. "If it begins looking like that's not going to happen then we'll see even more vulnerabillty. So, for now nothing solid for the bulls to hold onto except hope and always the concern that somebody says the wrong word."

Boehner declined to provide details of what approach he expects to take.

"I don't want to limit the options that would be available to me, or limit the options that might be available to the White House," Boehner said "There are a lot of ways to get there and I don't want to preclude anyone who might have a good idea about how we move forward. But it's clear, it's clear we've got to fix our broken tax system and we've got to fix our spending problem."

Traders are looking for signs of what the "common ground" might be to keep the economy from hitting the cliff, which is the $607 billion combination of taxes and spending cuts that will slam the economy starting Jan. 1 if Washington fails to act.

The Congressional Budget Office on Thursday reiterated that the economy would fall into recession early in the year, and unemployment could rise above 9 percent if no actions are taken.

"Both are going to kind of indicate again, and I think they already did, in Obama's victory speech and Boehner's speech on Wednesday that they're ready to consider some common ground approach," said David Gilmore, strategist with FX analytics.

(Read More: Congress - Fiscal Cliff Cuts Would Mean Recession)

"I think you don't have to be a genius to look at the stock market since Nov. 6," said David Gilmore, strategist with FX analytics. "They're getting a pretty good taste of what it would be like to carry on with business as usual.

Ward McCarthy, Jefferies chief financial economist, said before the speeches that the "common ground" could be an elimination of deductions, rather than a return to the upper tax bracket of 39.6 percent for the richest Americans.

"What you want to hear them say is there's some common ground because there's been no indication so far that they have been able to narrow the gulf between Boehner's clearly stated opposition that has continued after the election that he is opposed to increases in marginal tax rates, but not necessarily increases in tax revenues, and President Obama's resistance to extending tax cuts for people who make more than $250,000. Something has to give," he said.

McCarthy expects the process to go well into next year and he expects it to be difficult. Some analysts expect Congress to find away to punt the problem into next year, by partially resolving some issues this year.

"This is not going to go smoothly and I'm not optimistic about what happens between now and yearend, but I am optimistic that some type of coherent agreement will be reached by the middle of next year," he said. "The fiscal cliff is going to morph into fiscal water torture. There will be a series of crisis driven events that force them to address the budget, and it will happen right after the inauguration because that's when the debt ceiling will become a binding constraint and when that happens it threatens the Treasury auctions and it threatens government shutdown."

(Read More: Next Up for Markets? The Fiscal Cliff)

McCarthy said the resolution should involve tax reform.

"There are so many loopholes and gaps in the tax code that really should just be eliminated. If you kept the same marginal tax rate structure and eliminated a lot of deductions and loop holes, and especially if you eliminated them beyond certain income levels, that would frankly raise more money," he said.

"In political speak, I think Boehner has already put on the table what he thinks the common ground on taxes could be and that is more revenues by broadening the base," McCarthy said. "Broaden the base means taking away deductions and loop holes."

(Read More: 'Rise Above' - CNBC's Initiative on the Fiscal Cliff)

Treasury yields have fallen this week, as investors sought safe haven investments. Since the election, the S&P 500 and the Dow have lost about 3.5 percent. The 10-year yield dipped below 1.6 percent earlier Friday, for the first since early September, in part because of the fiscal concerns and partly because of continuing trouble in Europe.

-BY CNBC's Patti Domm