MARKETS

The central bank has signaled a gradual withdrawal of stimulus. But Larry Summers' withdrawal from consideration as Fed chief is a reminder that public events don't always follow a script, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

Larry Summers' letter, withdrawing his name from consideration to head the Federal Reserve when current chairman Ben Bernanke departs, presumably in January, is a reminder that even carefully watched, exhaustively reported, and endlessly handicapped events can produce BIG surprises.

Summers was, until his withdrawal, considered the front-runner for the job. Now, who knows?

Current vice-chair Janet Yellen? Donald Kohn, Number two at the Fed until 2010? A dark horse candidate such as Roger Ferguson, Stanley Fischer, or Jeremy Stein? Could Tim Geithner, former Treasury Secretary, be in the running, despite his frequently expressed disinterest in the job?

Something that seemed settled is wide open again. And the effects on the financial markets are certain to be far-reaching. Can I envision anything nearly as surprising for Wednesday's decision by the Federal Reserve's Open Market Committee on beginning/not beginning to slow the pace at which the Fed is buying Treasurys and mortgage-backed securities? After all, the markets have had months to masticate any tapering in Fed purchases. You'd think the decision would be priced into financial assets by now.

I don't see much chance of a direct surprise. I think the big, liquid global markets—like those for Treasurys and currencies, such as the dollar, yen, and euro—have discounted a modest Fed taper sometime before the end of 2013. In a recent Bloomberg poll, 57% of investors say they don't expect a sudden change in the markets if the Fed does decide to start a taper on Wednesday. Their reason? They say they already anticipate a Fed taper.

I doubt that a Fed decision to taper this week or wait until October is going to produce more than a blip in the markets I've noted above, or in the big liquid developed economy stock markets.

But that doesn't mean I'm ruling out all chances of surprise.

I think we could get a surprise in less-liquid markets, which is where worry is most intense right now. That wouldn't require a change in the markets, just a continuation of recent direction.

And that reaction could circle back to the globe's biggest asset markets. I doubt that's likely, or that any move in developed markets would be big or long-lasting. But that's definitely where I'd be looking for any surprise in the last half of this week.

Let me take you on a brief tour of potential surprises.

The Fed is currently buying $85 billion in Treasurys and mortgage-backed assets each month, in order to lower medium-term interest rates. (The Fed controls short-term interest rates directly and has said that it will keep short-term interest rates at their current "extraordinarily" low level of 0% to 0.25% until 2015. The Fed has been trying to lower medium term rates in the vicinity of seven-year maturities.)

The consensus is that the Fed, whenever it begins to taper, will do so very modestly, cutting back purchases from $85 billion a month to $75 billion or so. The first surprise, then, would be if the size of the Fed taper significantly exceeded $10 billion. A drop to, say, $70 billion, would be aggressive, but probably not enough to rattle the consensus. A drop to a level lower than that would indeed be a surprise, and would undoubtedly lead to a selloff in both the bond and stock markets. I think the likelihood of a drop on that action is abundantly clear to the Federal Reserve.