All eyes will be on the Federal Reserve meeting next week, when Fed officials will decide whether or not to raise the federal funds rate for the first time in almost a decade. But one strategist sees one big problem that could derail any plans for a potential rate hike.
Larry McDonald, head of U.S. macro strategy at Societe Generale, said the Fed will likely hold off on raising rates because of weakening credit and trouble in currency markets. McDonald pointed to credit default swaps widening on the heels of another tumble for China's yuan, which hit a four-year low on Friday.
"The credit market weakness is so profound in high yield, emerging markets debt and leveraged loans that that could veto the Fed's policy path and present a much more dovish Fed," McDonald said Thursday on CNBC's "Trading Nation."
The high-yield market has been badly beaten this year, with the high-yield bond ETF HYG tumbling more than 2 percent on Friday to its lowest level since 2009.
If the Fed does decide to raise rates, McDonald said the magnitude of the rate hike should fall below economist expectations.
"They may not [hike] because of the credit risk that we're seeing but even if they do, the policy path will be much more shallow," McDonald said. "The amount of hikes over the next year isn't going to be anywhere near what the Street expects."
Looking at the charts, Rich Ross of Evercore ISI said investors should watch the spread between the U.S. two-year Treasury note yield and the U.S. 10-year Treasury note yield as the Fed contemplates raising rates. The two-year yield is up 33 percent year to date while the 10-year yield has fallen, which Ross said could be another sign of trouble.
"You don't want to see the two-year yield continue to surge as the Fed raises interest rates and 10-year yields go nowhere or lower, giving us a flatter curve. That's the worst of both worlds, that's higher rates without the growth to support them," Ross said Thursday on "Trading Nation."