The Federal Reserve's tightening campaign enters a new phase today that — paired with rapid interest rate hikes — will be hard for financial markets to predict.

Why it matters: At the onset of the pandemic, the Fed injected stimulus into the economy at an unparalleled scale. Now it will step up the withdrawal of that support, part of a two-pronged approach aimed at crushing inflation.

• With quantitative tightening (QT) entering full speed as of today, the question now is if it will cause things to break in the financial system.

Catch up quick: As the pandemic hit, trillions of dollars' worth of Fed stimulus (quantitative easing, or QE) helped ease financial and economic conditions, and swelled its balance sheet by $5 trillion in just two years.

• But as the Fed sought to tighten policy to ward off rising inflation, it began a drawdown of its balance sheet by letting bond holdings roll off earlier this year. Starting this month, QT enters a more aggressive phase.
• The central bank plans to cut its massive bond holdings by up to $95 billion per month, twice as fast as it had been reducing its stockpile since June.
• The result is over $1 trillion each year being sucked out of the financial system as it continues to swiftly raise interest rates — a one-two punch of monetary tightening.

The big picture: Fed rates, the central bank's primary policy tool, get a lot of the attention. But in the background, the balance sheet operates on autopilot.

• "I don't think that they know as well what the macroeconomic effects are of adjusting the balance sheet. They'd rather not be trying to talk about both tools simultaneously," said Bill English, a professor at the Yale School of Management who served as the head of the Fed's monetary affairs division.
• Still moving even more quickly to scale down the balance sheet is an option, in an extreme scenario, if the Fed believes financial conditions aren't tightening enough.
• There's still an open question about whether the Fed will eventually decide to sell its mortgage-backed securities outright, an action that would likely push mortgage rates up even further.

The other side: Some analysts suspect that if markets become more turbulent, it could stop QT in its tracks.

• In 2019, the Fed abruptly ended its inaugural attempt after a big hiccup in the critical funding market that underpins much of the financial system.
• The Fed intervened with billions of dollars in emergency funding to quell the chaos.

July was a blockbuster month for job growth. We find out tomorrow morning whether August continued the trend.

• New data out today points to a labor market that remains extremely strong.

Why it matters: We're in an "up-is-down" world with the labor market, in which the Fed actually wants to see things cool down to lower demand in the economy. So a "good" jobs report may actually mean higher risk of a recession ahead, as it would lead the Fed to be more aggressive.

• If August's job and wage growth turn out to be strong, and/or the unemployment rate drops further, another 0.75 percentage point rate increase later this month will be highly likely.

Driving the news: Forecasters expect to see another 300,000 jobs added to U.S. payrolls (following a 528,000 July number), the unemployment rate unchanged at 3.5%, and a 0.4% rise in average hourly earnings. It comes as other data points to a robust jobs situation.

• The number of people filing new claims for jobless benefits fell to its lowest level in two months last week, the Labor Department said. Only 232,000 new claims were filed — far from what you would expect to see in a recession.
• The Institute for Supply Management's survey of manufacturers was unchanged overall for August, but showed a strong surge in the employment component of the index. It rose to 54.2, from 49.9 (50 represents the line between expansion and contraction).