A Fed decision could hinge on the dollar: Larry McDonald

Figuring out the Fed's path

Wondering what the Fed will do next? Risk from a strong dollar could change the central bank's policy path, one expert said.

"The credit risk deterioration we saw in July only happens at that speed right around or before recessions," Larry McDonald, head of U.S. strategy at Société Générale's macro group, said Monday on CNBC's "Power Lunch." "If you look at the major credit indices, whether it be high-yield bonds, investment-grade bonds, emerging market bonds ... credit markets could impact the Fed policy path going forward."

For months, financial markets have eyed the timing of a Federal Reserve rate hike amid concerns of global volatility. But some key indicators, including a strong dollar, could push the rate rise out to 2016, or even spur quantitative easing in the U.S., McDonald said Monday in a note.

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"Eighty percent of analysts, strategists, economists a year ago said the Fed was going to hike in June or September," McDonald said. "The whole world has been waiting for this rate hike, that's why the dollar surged."

A survey of Global Asset Managers found that 67 percent see the U.S. dollar strengthening next 12 months, McDonald told CNBC in a note. In addition to hampering trade, the strong dollar has particularly hindered the manufacturing sector, measured by indicators like the Institute for Supply Management (ISM) manufacturing index and the purchasing managers' index, he wrote.

With job creation already tepid, McDonald told CNBC in a note that wage growth could be too soft to counteract the weakness in the manufacturing sector.

"I really feel the Fed has to contain the dollar to put out this global fire," McDonald said on "Power Lunch." "The dollar has made a 27 percent move in the 19 months and it's really behind lot of this credit risk."