The precipitous sell-off in U.S. equities could put the Federal Open Market Committee (FOMC) in a bind in the upcoming meeting this week. Take aggressive steps to fight inflation and risk a further sell-off in equities, or go slow and risk losing credibility in fighting inflation.

Technology shares listed on the NASDAQ have been selling off since the beginning of the year, as long-term interest rates have climbed. Last week, the benchmark 10-year Treasury bond traded with a yield of around 1.9%, the highest it has been in the previous two years. Due to the rise in inflation, which runs at an annual rate of about 7%, it's the highest it has been in the last 40 years.

Inflation undermines the value of money invested in fixed-income securities like bonds. Thus, investors demand a higher return to compensate them for these losses, which drives bond prices lower and yields higher.

To fight inflation, the Federal Reserve has already begun its bond tapering program, the rolling back of its purchases of Treasury bonds and mortgage-backed securities, meaning that the nation's central bank slows down the pace of adding liquidity (accommodation) to the economy. Tapering will end in March and be followed by tightening, taking liquidity out of the economy.

Both long-term and short-term interest rates are heading higher soon. And that's a negative development for equities, as they make future earnings less valuable when discounted to the present, especially for companies that expect to be profitable sometime in the distant future, as is the case with many technology companies trading on the NASDAQ.

The rise in interest rates comes as listed companies face supply chain bottlenecks and labor shortages, which squeeze profit margins and make these companies less appealing to investors, adding to the selling pressure of equities.

The precipitous decline in NASDAQ shares poses a risk to both the financial markets and the economy. They may cause another market crash, pushing the economy into a recession. As a result, the FOMC is in a bind in the upcoming meeting over the timing and the pace of tightening: Be aggressive and risk a market crash or move slowly and risk falling "behind the curve," losing credibility in the fight against inflation.

In a research note last week, Deutsche Bank expects the Committee to take a rather aggressive (hawkish) stand regarding both tapering and tightening.

"The meeting statement should provide a clear message that the Committee will soon begin the process of removing policy accommodation, strongly signaling the potential for liftoff at upcoming meetings," said Deutsche Bank. "The first move in this direction should be evident in the opening line of the meeting statement, which has been unchanged since the beginning of the pandemic."

Greg McBride, chief financial analyst at Bankrate, sees the FOMC taking a hawkish stand.

"The Fed doubled the pace of tapering at their last meeting in December. Rather than waiting until March, why not sunset those bond purchases altogether at this meeting? That would better align the Fed with the hawkish inflation stance and better position them to actually let bonds begin rolling off their balance sheet as soon as March," said McBride.

Financial markets do not usually like a hawkish Fed. But that’s what the economy needs at this point to get rid of inflation. Will markets warm up to this reality?

On Wednesday, we'll know which side the FOMC is on and how Wall Street responds.