NEW YORK, May 20 (Reuters) - The Federal Reserve's
determination to raise interest rates until it squashes the
highest inflation in decades is darkening the outlook across
Wall Street, as U.S. stocks stand on the cusp of a bear market
and warnings of a recession grow louder.
At issue is the so-called Fed put, or investors belief that
the Fed will take action if stocks fall too deeply, even though
it has no mandate to maintain asset prices. One oft-cited
example of the phenomenon, which is named after a hedging
derivative used to protect against market falls, occurred when
the Fed halted a rate hiking cycle in early 2019 after a stock
This time around, the Feds insistence that it will raise
rates as high as needed to tame surging inflation has bolstered
the argument that policymakers will be less sensitive to market
volatility - threatening more pain for investors.
A recent survey by BofA Global Research showed fund managers
now expect the Fed to step in at 3,529 on the S&P 500,
compared with expectations of 3,700 in February. Such a drop
would constitute a 26% decline from the S&Ps Jan. 3 closing
The index, which closed Friday at 3,901.36, is already down
almost 19% from that high this year on an intraday basis - close
to the 20% decline that would confirm a bear market, according
to some definitions.
"The Fed has bigger fish to fry and that's the inflation
problem," said Phil Orlando, chief equity market strategist at
Federated Hermes, who is increasing his cash levels. "The 'Fed
put' is kaput until the central bank is confident that they're
no longer behind the curve."
As a result, some investors are digging in for a long slog.
BofAs survey showed cash allocations at a two-decade high,
while bets against technology stocks stand at their highest
Strategists at Goldman Sachs, meanwhile, earlier this week
published a Recession manual for US equities in response to
client inquiries on how stocks will perform in a downturn.
Barclays analysts said that numerous negative near-term
catalysts mean the risks for stocks remain firmly stacked to
The S&P 500 closed broadly unchanged on Friday, reversing a
sharp intraday decline that had briefly put it into bear market
territory. The index marked its seventh straight week of losses,
the longest streak since 2001.
Jason England, global bonds portfolio manager at Janus
Henderson Investors, believes the index needs to fall at least
another 15% for the Fed to slow its tightening, given that
unprecedented monetary policy support helped stocks more than
double from their March 2020 lows.
"The Fed is being very clear that there will be some pain
ahead," he said.
The Fed has already raised rates by 75 basis points and is
expected to tighten monetary policy by 193 basis points this
year. Investors will get more insight into the
central bank's thinking when minutes from its last meeting are
released on May 25.
Some worry the Fed risks exacerbating volatility if it does
not heed possible danger signs from asset prices. Analysts at
the Institute of International Finance said stocks may be
subject to the same type of selling that rocked markets in late
2018, when many investors believed the Fed tightened monetary
policy too far.
In the past, rising uncertainty and mounting recession risk
have had important effects on investor psychology, making
markets less tolerant of monetary policy tightening that is seen
as no longer warranted, IIF analysts wrote on Thursday. The
risk of a similar market tantrum (to 2018) is rising again now
as markets fret about global recession.
There have been signs of resilient sentiment among
investors. For example, the Cboe Volatility Index, known
as Wall Streets fear gauge, is elevated but below levels it
reached during previous major selloffs.
And the ARK Innovation Fund, which became
emblematic of the pandemic rally, has brought in net positive
inflows of $977 million over the last six weeks, Lipper data
showed. The fund is down 57% in 2022.
While some investors say those are signals that markets are
yet to bottom, others are more hopeful.
Terri Spath, chief investment officer at Zuma Wealth,
believes some investors are re-entering parts of the stock
market that have suffered outsized losses.
"The Fed is already seeing signs that they won't be needed
as a buyer of last resort," she said.
Analysts at Deutsche Bank are less optimistic.
"The Fed having badly erred on the side of excess inflation
in 2020/21, cannot afford to make the same mistake twice - which
favors more financial conditions tightening, and ongoing high
(volatility) panicky markets," they wrote.
(Reporting by David Randall in New York
Editing by Ira Iosebashvili and Matthew Lewis)