Let’s assume for a moment the Federal Reserve starts to taper and the economy does just fine. Economic data remains decent and GDP continues to grow at a modest pace. What will the Fed do if the economy can handle "less Fed intervention"? The assumption is the Fed will decide to taper more quickly. If it is determined that tapering doesn't hurt the economy, expect the Fed to taper at a faster rate, which given the current environment will likely hurt stocks more than bonds. Volatility will likely increase.
Now let's assume the Federal Reserve starts to taper and it impacts the economy. Economic data starts to show a decline in activity and GDP growth slows markedly. Will the Fed stop tapering and start buying again? Very likely. But the market may not assume this outcome and may decline. In this crazy, upside down world the Fed has created, it's very possible that the Fed will taper, economic data gets worse, the Fed "un-tapers", starts purchasing again, and markets rally as they realize the Fed and QE is here to stay. Volatility will likely increase in this scenario as well.
