A handful of traders actually think the Fed could hike a half point this week 

  • Action in the fed funds futures market this week indicates an 8 percent chance that the Fed will approve a half-point interest rate hike this week.
  • While there's practically no chance of that happening, with the last move that big coming 18 years ago, the trading indicates a market coming to grips with a more hawkish Fed.
  • The Federal Open Market Committee is widely expected to approve a 25 basis point increase that will take the target range for its benchmark rate to 2 percent to 2.25 percent.
Federal Reserve Chairman Jerome Powell testifies before a House Financial Services Committee hearing on the “Semiannual Monetary Policy Report to Congress," at the Rayburn House Office Building in Washington, U.S., July 18, 2018. 
Mary F. Calvert | Reuters
Federal Reserve Chairman Jerome Powell testifies before a House Financial Services Committee hearing on the “Semiannual Monetary Policy Report to Congress," at the Rayburn House Office Building in Washington, U.S., July 18, 2018. 

Everyone knows the Fed is virtually a lock to approve a quarter-point rate hike this week. Some traders, though, think the central bank could get even more aggressive.

The fed funds futures market, where traders make their bets about the direction of interest rates, is indicating a 92 percent chance that the policymaking Federal Open Market Committee will move its target rate range to 2 percent to 2.25 percent, or 25 basis points from the current level.

In recent days the market also has been entertaining the possibility of a more aggressive move — a 50 basis point hike, for which there is now an 8 percent chance. A week ago, such a move had only a 2 percent likelihood, and a month ago traders gave no chance to a half-percentage point move.

However, as Fed rhetoric has taken a hawkish bent and as the FOMC's meeting date has drawn closer, the market has rethought the direction of monetary policy.

While the chance of the committee actually approving a half-point hike is remote to say the least — there hasn't been an increase that large since May 2000 — the latest trading action is telling in terms of expectations. A market that had been pricing in a dovish Fed is now doing some adjusting.

"With the Fed seemingly all but on autopilot for a while, the bond market has some catching up to do as well," Goldman Sachs economist David Mericle said in a note. "Investors have found a range of reasons this year to price substantially fewer hikes than we and the median FOMC participant anticipate ... We have been skeptical of these arguments and see recent Fed commentary as broadly supportive of our take. Markets have moved in this direction, but there is further to go."

Indeed, the market has gravitated toward a more aggressive Fed.

Since the committee released minutes Aug. 22 from its most recent meeting, the yield on the benchmark 10-year Treasury note has risen a quarter point to its highest level since mid-May. Traders are assigning an 84 percent chance to another rate hike in December.

However, 2019 remains an open question. Fed Chairman Jerome Powell will hold a news conference when this week's two-day meeting concludes Wednesday, so markets will be watching closely for any clues about the future.