With everyone wondering whether the Fed will capitulate on its 3-hike dot plot forecast on Wednesday, at least one variable can be put to bed: as UBS fixed income sales specialist Dan Noorian writes, "no one seriously expects the Fed to leave rates unchanged on Wednesday".

Beyond that, however, it becomes problematic: as Noorian explains, investors have been willing to position for a pause in March 2019, but the majority seem intent on continuing to play for further hikes, with the UBS traders noting that EDZ9 has rallied 36bp in the last 30 days, pricing out that much tightening, and adding that it "makes sense to short here" as risk: reward still favors higher rates. In other words, pretty much anything Powell does would be seen a hawkish by the market which has already priced out all rate hikes in 2019.

Market flows confirm as much:

The major options flows over the past few sessions have been skewed to downside, especially in 1y March mid-curves. In Eurodollar futures, curve inversion has motivated a number of accounts, both real money and hedge fund, to get back into Eurodollar steepening trades.

Additionally, a part of the problem with buying into the fixed income rally at current levels is that it's making a bold statement about a strong US slowdown coming; yet despite concerns about the global economy, US data remains strong, the UBS strategist notes and notes that in the Druckenmiller and Warsh op-ed overnight, both warn that "no ocean is large enough to insulate the US economy", but more likely seems a few quarters of Fed pause in 2019 before it resumes the hiking cycle.

But the biggest problem by far, at least according to Noorian is that should Powell fold, and the Fed's dot plot shows a reduction in the path of rate hikes on Wednesday "fixed income markets won't react rationally, and the Eurodollar curve will invert further".

The move could be made worse by accounts with limited tolerance for year-end losses stopping out of recent steepeners as "short the front end remains the dominant position".

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The result could be chaos in the bond market as "fixed income feels to be nearing a turning point". Why? Because as UBS cautions, most accounts spent the year selling rallies in major fixed income markets. This was a successful strategy at the start of the year but has struggled in recent months. As a result, one of the biggest risks to this entrenched short position is a change in stance from active investors, such as would occur if the Fed signaled a pause; these accounts would become dip buyers, and the shorts would again be squeezed out.

Finally, looking at trading over the next 48 hours, Noorian writes that he wouldn’t expect much to happen between now and the Fed result Wednesday as "Christmas trading is starting to take hold, with volumes on exchanges dwindling" and as a result "it will be interesting to see just how much appetite accounts have to shift risk around after the Fed meeting". There is little data to go on past Wednesday, with just the third release of US Q3 GDP on Friday.

So if fixed income does manage to sell off, this would suggest that the bulk of market participants will be looking to start the year exactly how it began 2018, short.