ONE THING SEEMS CLEAR AS THIS fitful season draws to a close: The recently range-bound stock market has the capacity to rally this fall. Whether it will is another matter.

Stocks bounced back Friday from their lowest level in nearly eight weeks after the central bank outlined the weapons in its dwindling arsenal for bolstering our economy. There were no surprises, no specific course of action, yet it was good enough for a 1.7% bounce. There were other signs that a market anticipating the worst is easier to appease: Intel (ticker: INTC) cut its revenue forecast, but a chip sector that has already pulled back 13% over the past month rallied 1.4% Friday. A recalcitrant Boeing (BA) warned of yet another delay in delivering its 787 Dreamliners, but shares rallied anyway.

How much economic woe is already priced in? It seemed we’ve spent much of this summer fretting about Europe’s sovereign debt, China’s tightening credit and our own economic vulnerability, in between sightings of Hindenburg omens and death crosses. Even our central bankers are worried. And “Hands up!” anyone who still believes our politicians can fix this mess (don’t all rush at once). But while stocks aren’t egregiously expensive, they can fall 10% to 20% if the merely stagnant job market worsens anew. Can you blame investors for being blasé, with bulls barely buying and bears barely selling?

American companies have the means to hire more employees and order new equipment this fall. Corporate profits as a percentage of gross domestic product are pushing 40-year highs. Costs have been cut to the bone. Cash vaults are at the fullest in decades. But what companies lack is the gumption. And CEOs can’t pull the trigger on hiring or spending until today’s economic and policy fog lifts.

Will it? Deleveraging and paying down debt is a long, cheerless slog, but some recent red flags may prove temporary. Jobless claims ticked up recently to a vexing nine-month high partly because a new law this July restored unemployment benefits to 2.5 million people—and not all because there were layoffs anew. The financial markets seized up in May as Europe struggled, triggering the hesitation now showing up in economic indicators, but financial conditions have eased fitfully since then. A 27% plunge in sales of existing U.S. homes in July isn’t wholly shocking, since homebuyer tax credits that expired in the spring had pulled forward much of the demand.

As if Washington needs any more hurdles, a short window of just 20 legislative days leaves little time this fall to enact measures that might create jobs, stimulate the economy or reduce our debt. Campaigning and posturing for the midterm elections adds another distraction. But the faltering recovery has increased odds that the Bush tax cuts might get extended.

It’s a lot to ask our politicians to get their act together, but a little resolution and clarity could go a long way. Policy uncertainty and collective breath-holding explain why the market typically muddles along before midterm elections, rising just an average 1.2% all year leading up to Election Day, notes Bespoke Investment Group. But once that’s over, stocks gain an average 3.2% for the rest of the year. Over the last 16 mid-term years, the market has never made a new low post Election Day, but it has climbed to new highs on seven occasions.

Friday’s bounce couldn’t save the Dow Jones Industrial Average from its third straight weekly loss, and the blue chips ended the week down 63, or 0.6%, to 10,151. The Standard Poor’s 500 has lost 5.1% over three weeks. The Nasdaq Composite Index lost 26, or 1.2%, to 2154, but the Russell 2000 added 6, or 1%, to 617 for its second weekly gain.

AS THE THREAT OF DEFLATION INCREASES, so will the government’s efforts to fight it. The Fed has always had the tool–printing presses–to stoke inflation, one reason why a dollar from 1913, the year the Fed was created, is worth just four cents today after adjusting for inflation. Should we worry now that the Fed has a motive?

“If deflation risk increases, we think more unconventional pro-inflation policy will come,” notes Morgan Stanley strategist Gerard Minack. No government wants runaway prices, but a policy error cannot be ruled out. “It’s certainly possible to create inflation,” says Minack. But “we doubt policy makers’ ability to create just the right amount.”

With paper currencies not worth much in the bank, where they earn almost no interest today, and depreciating even under our Tempur-Pedics, it’s no wonder hard assets continue to draw investors. Despite the specter of deflation, prices are up 23% this year for cotton, 18% for cattle, 43% for wheat, 18% for nickel, 10% for silver, 9% for gold and 6% for copper.

Inflation isn’t an immediate threat, but inflationary policies make the uncertain market riskier. “The strategies that would succeed as deflation fears increase are almost exactly the ones that would not succeed if the market suddenly focused on an inflation end-game,” Minack notes. Even a mild uptick in inflation expectations could rattle debt markets at today’s yields. Not surprisingly, gold, which has coped with both deflationary and inflationary regimes, is flitting near its all-time high.

Meanwhile, crude oil has pulled back 15%, and energy stocks are the worst performers in the S&P 500, down 11.5% so far this year. With the Select Energy SPDR (XLE) slumping well below its 200-day and 50-day averages, even a momentary easing of deflation fears could help the energy sector close the performance gap – at least short-term (Source: Barrons Online).