Fed Pause Could Spark Market Volatility as Hike Odds Hit 87%

The Federal Reserve is set to make its decision on interest rates this week, but investors are now more concerned about what will happen if there's a pause rather than a hike. According to market traders, there's an 87% chance of a 25 basis point increase in the federal funds target range, which could rise to 3.5% to 3.75%. This decision comes after hotter August inflation and higher oil prices.

Goldman Sachs and JPMorgan have both changed their stance on interest rates, with Goldman now expecting a quarter-point increase. However, investors are worried about the potential market reaction if the Fed doesn't deliver a hike that recent communication has guided the market to expect. A pause could revive doubts about the Fed's inflation credibility and push long-term Treasury yields higher.

Investors have adjusted to higher short-term rates, but a hike could still pressure rate-sensitive assets. On the other hand, doing nothing has become the more disruptive trade for financial markets, with normally expected support for bonds potentially turning into tighter financial conditions.