The Fed Could Crush the Stock Market 

The market is expecting another big rate hike from the Fed.

But how big that rate hike could be is still a mystery.

August data showed that the Fed still has work to do to rein in inflation.

Since inflation data for August came in hotter than expected last week, investors have been on edge. The market sent the Dow Jones Industrial Average tumbling by more than 1,100 points last week. Despite the pain, the worst still may be to come, with the Federal Reserve's September meeting kicking off today and wrapping up tomorrow. Here's how the Fed could crush the stock market tomorrow and also why you shouldn't panic.

What kind of rate hike is coming?

In August, the Consumer Price Index (CPI), which tracks the prices of a range of daily consumer goods and services, rose 0.1% from July and was up 8.3% year over year. Economists had been penciling in a 0.1% decline from July and the CPI being up 8% year over year. The bigger increase spooked investors because many had assumed that inflation had peaked and could be headed south, but the CPI report did not show this.

The longer inflation persists, the longer the Fed has to stay hawkish and raise interest rates, which has roiled markets this year because investors are worried that intense rate hikes will push the economy into a severe recession.

Prior to the August inflation data, the market expected the Fed to raise interest rates by 0.50% or 0.75% following two 0.75% rate hikes at both of the Fed's June and July meetings. After the disappointing inflation data, the market is all but certain there will be at least a 0.75% rate hike, but now some investors think the Fed could even surprise with a full 1% hike.

According to the CME Group's FedWatch Tool, there was an 82% chance on Monday that the Fed would hike its benchmark overnight lending rate, or the federal funds rate, by 0.75% and a 18% chance the Fed would implement a full 1% hike on Wednesday. However, that number had been as high as 20% on Monday morning.

I do think a 1% hike would seriously crush the stock market tomorrow. It would be the largest single move by the Fed since the Fed began using the federal funds rate in the 1990s, according to Bloomberg. I also think it would send a message to the market that the U.S. economy has a more serious inflation issue than anyone could have imagined -- even at this point -- if the Fed has to do the full 1% hike.

At a conference earlier this month, Federal Reserve Chairman Jerome Powell said he is worried that a similar situation that happened in the 1970s when "the public had really come to think of higher inflation as the norm" could play out now. Powell blamed the Fed in the 1970s for not staying hawkish enough to rein in inflation.