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Fed will not be deterred from hiking rates

Janet Yellen, chair of the Federal Reserve, speaks after a Federal Open Market Committee meeting in Washington, Sept. 17, 2015.
Andrew Harrer | Bloomberg | Getty Images
Janet Yellen, chair of the Federal Reserve, speaks after a Federal Open Market Committee meeting in Washington, Sept. 17, 2015.

The terror attacks on Paris are not likely to be a catalyst that would deter the Fed from raising interest rates, unless they lead to more extreme uncertainty and financial conditions deteriorate significantly.

The stock market traded higher Monday morning amid speculation the Fed could delay hiking rates because of volatile markets or economic weakness. The futures market, however, continued to place high odds of a December rate hike, at around 65 percent.

Stocks stabilized Monday after S&P 500 futures initially plunged Sunday night. The so-called Islamic State has claimed responsibility for the Paris attacks as well as recent bombings in Beirut and the downing of the Russian passenger plane in Egypt.

"It's something that really has to cause uncertainty in the U.S., such that it causes business and consumers to shut down, not take on risk and spend little," said Chris Rupkey, chief financial economist at Bank of Tokyo Mitsubishi. Rupkey said a major military response to the attacks could sway the Fed.

Investors are watching to see if France, which bombed ISIS targets on Sunday, asks all of NATO to step up military efforts.

"if there's a full scale invasion of Syria, it could give the Fed pause especially if that uncertainty causes a pullback on the part of business and the consumer," said Rupkey.

But Fed watchers say it's too soon to tell what will happen, and it's unlikely the Fed at this point would see a change in its outlook.

"It's a much higher bar for the Fed not to raise rates than the market thinks," said John Canally, market strategist and economist at LPL Financial. Fed officials, including Fed Chair Janet Yellen, have made clear they would like to raise rates on Dec. 16, if the economy is strong enough.

The dollar firmed Monday and the euro was slightly lower, at $1.07. Stocks were higher Monday afternoon. In the Treasury market, the 2-year yield was at 0.84 percent. The 2-year is the sector that is most sensitive to Fed policy.

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Strategists said the incident, if anything, will highlight the divergence between Fed policy and the European Central Bank. "If the Fed's going to hike regardless, and the ECB's going to do more, it should be upward pressure on the dollar, and downward pressure on the euro," said Canally.

The market has been expecting a move toward parity, and the attacks could accelerate the moves in the currency pair.

There are concerns, however, that the U.S. economy is slowing, and that could be what stops the Fed from moving in December. The New York Fed's Empire State Survey showed more evidence Monday of a manufacturing slowdown. The index came in at negative 10.7, below the consensus and the fourth negative reading in a row.

"We don't have a very robust U.S. economy. We have a fragile global backdrop and the tragedies that just took place aren't going to help risk taking and growth so we have another thing to worry about," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank.

LaVorgna has not expected the Fed to hike this year. "I still am of the view they're not going because I don't see how the ECB is going to be very aggressive and the Fed's going to be hiking," he said.

The ECB is expected to expand its quantitative easing program and possibly cut its already negative deposit rate at its early December meeting.

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"I think the other thing that would make the Fed pause is if you get a severe tightening of financial conditions between now and month from now that would be a substantially stronger dollar and weaker euro," Canally said.