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The worries over inflation have not abated in recent months. These concerns, rather, have increased significantly in recent weeks. Yesterday’s CPI reading of 7.5% and a core reading of 6% are the highest seen since 1982. The hotter than expected inflation data is shifting Fed expectations and may cause the central bank to hike rates faster or stronger than previously thought. Fed Funds futures are now pricing in a very strong likelihood of a 50- basis point hike in March rather than a 25- basis point increase.

A 50-basis point hike is significant for a few reasons. The Federal Reserve has not hiked rates by a half-point since the year 2000. At that time, the rate hike marked the end of the dot.com bubble which then saw markets decline significantly. Whether this time around has similar effects remains unknown. The Fed hiking by a half-point, however, is akin to the Fed unleashing a bazooka. Such a shock and awe type of move from the Fed is not unlikely, however, given how far the central bank has fallen behind the inflation curve. The question is what is the Fed willing to give up in return for a shock and awe rate hike? Such a move would almost certainly have an immediate and sharp bearish effect on the economy. Stock investors could quickly head for the hills, and equity markets could potentially see a sudden reversal or sell-off. Volatility would also likely increase substantially, and the markets could enter a prolonged period of heightened volatility as investors attempt to reprice assets and interest rate risk.

The bond market appears to be pricing in a half-point hike next month. The gold market seems to be on the fence, however, and does not appear convinced the Fed will take such action in a few weeks. The gld bulls, in fact, are pushing prices higher today, inching closer and closer to key resistance in the $1850 area. An upside breakout of this level on a closing basis would likely attract further buying interest and could set the stage for a rapid rally higher towards previous all-time highs or beyond. A failure of the bulls to take this level out, however, could potentially set up a sharp and significant leg lower. The bears are looking to take prices below the $1800 and then the $1780 levels on a closing basis. Success in doing so could mark an important turn for the market, and remaining bulls may become far more likely to throw in the towel at that point.

The next several weeks until the March Fed meeting may see volatility on the rise as expectations are repriced. That volatility could be settled down, however, if the Fed provides useful information at its March meeting. The central bank will have to offer an explanation if it hikes by a half-point rather than a quarter-point. If the Fed does a good job of laying out how it plans to proceed, markets may find some respite and calm. If the Fed leaves more unanswered questions, however, or lacks any real clarity in its remarks, look out below. Stocks and risk assets could fall hard and gold could potentially stand to benefit as investors seek out alternatives that may offer protection from inflation and preserve purchasing power.