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The Federal Reserve's September cliffhanger

On Wednesday, the Federal Reserve set the stage for some high drama in September: Its latest policy statement was the shortest since August 2012 and didn't definitively flag the central bank's policy path.

The key phrase was that it needed only "some further improvement" in the job market before rate hikes will start, which is a hawkish takeaway.

Michael Feroli at JPMorgan believes the addition of "some" from the prior statement indicates "the Fed is getting closer to hiking rates." The U.S. dollar surged higher in response with the PowerShares US Dollar Index Fund (UUP) breaking a three-week downtrend.

Fed Chair Janet Yellen says interest rate hik... 07:04

Fed policymakers appear frustrated by tepid wage growth and still-low inflation. The latter is the result of both recent energy price declines and the demand-side drag from slowdowns in China and Europe.

But Janet Yellen & Co. seem ready to start a policy tightening campaign for the first time since 2004. Once again, the fate of the free world seemingly rests on a decision out of the Marriner S. Eccles Building in Washington, D.C., which houses the Federal Reserve and where Yellen and her cohorts will decide whether to raise interest rates for the first time since 2006.

If they do, the fear is they'll undo layers upon layers of credit leverage that have supported stocks, the global financial system and the U.S. economic recovery over the last seven years.

A quicker-than-expected rate liftoff could throw stocks into their first 10 percent-plus correction since Ben Bernanke started QE3 in 2012 as more expensive capital cascades through the bond market, corporate junk debts and eventually into equities as the flow of debt-funded share buybacks is threatened.

Now that the stakes are set, Wall Street is doing its best to read the tea leaves Yellen is leaving behind.

Last Friday, an early release of leaked staff projections show the Fed is pricing in a one-and-done rate hike starting in September. Yellen's recent comments suggest she's looking to start tightening this year and would prefer to start earlier, rather than later, but to proceed more slowly with any subsequent hikes.

Yet the default expectation is that if there's any surprise, it'll be a delayed rate liftoff.

In September 2013, Bernanke surprised with a dovish "no taper" decision. Alberto Gallo, head of macro-credit research at RBS, believes traders are bracing for something similar because the market is already pricing in a 25 percent chance of no rate hike until 2016 vs. the 12 percent chance it saw at the start of the year.

"A rate hike could be delayed by slowing global growth, fears of a stronger U.S. dollar and Chinese financial volatility spreading to global capital markets," according to Gallo.

With futures pricing in only a one-in-three chance of a September rate hike, assets most at risk of a surprise rate hike -- another reaction like the "taper tantrum" seen in early 2013 when Bernanke first teased the tapering of QE3 in front of Congress -- would be U.S. high-yield bonds and emerging market corporate credits, according to Gallo.

Capital Economics U.S. economist Steve Murphy is more hawkish. He believes the Fed's July policy statement shows it's sticking with a forecast of two rate hikes this year, in September and December, which would take short-term interest rates from near zero now to a range between 0.5 percent and 0.75 percent.

After that, he sees "stronger wage growth and core inflation resulting in a much more aggressive pace of tightening than is currently anticipated by the markets and Fed officials, leaving the fed funds rate at 2.25 percent to 2.5 percent by end-2016."

Aside from "some," JPMorgan's Feroli spotted a few other language changes in the statement to support a September liftoff, including a characterization of job gains as "solid" and the removal of "somewhat" in reference to diminishing labor force underutilization.

Clearly, the Fed's July statement is just a hint of what could come in September.

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