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The market's fear gauge could quintuple by Halloween, strategist warns

The CBOE volatility index, widely regarded as Wall Street's "fear gauge" that measures implied market volatility, has traded in a narrow range this year, at one point hitting its lowest level on record. But all that's about to change, one market strategist forecast in a note to clients on Tuesday.

"We experienced a tremor last week, the bull has been wounded — a warning of things to come. We believe a new vol (volatility) regime is upon us — the VIX will touch 60 before we have pumpkins on our doorsteps," wrote Larry McDonald, head of global macro strategy and managing director at ACG Analytics.

The index, which closed on Tuesday at 12.04, would have to rise nearly 400 percent in a matter of months to touch the 60 mark, which it has not done since December of 2008 in the midst of the global financial crisis.

Here's how McDonald sees the index rising to such a level: The Federal Reserve will likely surprise the market with more interest rate hikes than is currently expected, which will in turn cause implied volatility to rise and shake up the markets.

The central bank will face further pressure to raise rates as rising commodity prices are likely to push up global inflation, McDonald said in a Tuesday afternoon interview with CNBC's "Trading Nation," recalling recent hawkish comments from New York Fed President William Dudley.

Dudley is a permanent member of the Federal Open Market Committee this year and will vote on monetary policy. He is also seen as an ally of Fed Chair Janet Yellen.

"If the Fed is a little bit aggressive here and surprises the Street, there's a very high probability that we sell off fairly dramatically, because the market's not expecting it," he said.

While traders currently see the chance of a December rate hike around 30 percent, McDonald sees that perceived chance soon shooting up to 60 percent.

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