Fed could 'realign' market's rate-hike forecast, economist says

The Federal Reserve could pull the rug out from under investors who are overlooking signs that policymakers could soon raise interest rates, according to Carl Tannenbaum, chief economist at Northern Trust.

Markets do not appear to be pricing in a rate increase despite upbeat U.S. jobs reports that bolster the case for a hike and hawkish statements from policymakers, Tannenbaum said Monday on CNBC's "Squawk Box." Despite the view of some economists that the Fed is following the market's lead, it would be relatively simple for the central bank to flip that dynamic, he added.

"At some point, if the Fed thinks the market misunderstands, there's a very clear way that they can realign those expectations, and that's by saying, look our economy is in very fine shape. It's different from others, so we don't have to do what other central banks are going to do, and in order to avoid financial excess down the road, we're going to remove just a little bit of excessive monetary accommodation," he said.

Low interest rates have pushed investors into riskier assets, raising concerns that stock prices and other assets have become artificially inflated. The Fed faces the prospect of raising rates at a time when central banks around the world are pushing them down or adopting negative interest rates in a bid to stimulate growth.

Tannenbaum made his comments after Fed Chair Janet Yellen on Friday said the case for interest rate hikes have strengthened . After the speech, Fed Vice Chair Stanley Fischer said the big numbers the Fed watches ahead of an interest rate decision are looking better.

Following those comments, expectations for a Fed interest rate in September ticked up, with purchases of Fed funds futures reflecting that buyers see a 33 percent chance of a hike. The odds are at nearly 36 percent for November and 44 percent in December.

Still, Deutsche Bank Chief U.S. Economist Joseph LaVorgna said the Fed remains a hostage to markets and will not hike at its Sept. 20-21 meeting. In recent history, the Fed has rarely hiked rates without Fed funds futures reflecting a roughly 70 percent chance of an increase.

"This Fed is led by the market perpetually. The Fed has arguably little credibility," he told "Squawk Box."

The Fed raised rates by a quarter of a percent from near zero in December, but has remained on hold since then due to concerns about disruptions in overseas markets, a dismal May jobs report, and potential fallout from Britain's vote to leave the European Union.

Ahead of its September meeting, the Federal Open Market Committee will be watching Friday's report on August jobs. It follows two-straight months of gains that topped 250,000 positions and blew away expectations.

The Bureau of Economic Analysis releases its latest reading on personal consumption expenditures, the Fed's preferred measure of inflation, at 8:30 a.m. ET on Monday.