With bear market approaching, collapsed Wall Street seeks out of reach “Fed status”

The Fed’s determination to raise interest rates until it crushes the highest rate of inflation in decades darkens expectations across Wall Street, as US stocks stand on the cusp of a bear market and warnings of an even higher recession grow.

The dispute revolves around the so-called Fed position, 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 of the most cited examples of this phenomenon, named after a hedge derivative used to hedge against a market downturn, occurred when the Federal Reserve halted its rate-raising cycle in early 2019 after a stock market tantrum.

This time around, the Fed’s insistence on raising interest rates as high as needed to tame rising inflation has reinforced the argument that policymakers will be less sensitive to market volatility — threatening more pain for investors.

A recent survey by BofA Global Research showed that fund managers now expect the Fed to intervene at 3,529 in the S&P 500, compared to expectations of 3,700 in February. Such a drop would constitute a 26% drop from the S&P’s closing high on January 3.

The index, which was recently at 3,840, is already down about 20% from that high this year on a daily basis — putting it on track to confirm a bear market, according to some definitions.

“The Fed has more fish to fry and that’s the inflation problem,” said Phil Orlando, chief stock market strategist at Federated Hermes, which is raising its liquidity levels. The Fed’s “position” is lukewarm until the central bank makes sure they are no longer behind the curve. “

As a result, some investors are digging a long way. The BofA survey showed that cash provisions are at their highest level in two decades, while bets against technology stocks are at their highest since 2006.

Meanwhile, strategists at Goldman Sachs earlier this week published a “Recession Guide for US Stocks” in response to customer inquiries about how stocks are performing in a downturn. Barclays analysts said several negative catalysts in the near term mean equity risks “remain firmly stacked to the downside”.

The S&P 500 index recently fell 1.5% on Friday, on course for the seventh consecutive week of losses.

Jason England, global bond 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 has helped stocks more than double from their lows March 2020.

“The Fed is very clear that there will be some pain going forward,” he said.

The Fed has already raised interest 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 the minutes of its last meeting on May 25 are released.

2018 Redux?

Some worry that the Fed risks exacerbating volatility if it does not heed potential danger signs from asset prices. Analysts at the Institute of International Finance said stocks could undergo the same type of sell-off that rocked markets in late 2018, when many investors thought the Federal Reserve had tightened monetary policy too much.

“In the past, rising uncertainty and rising recession risks have had significant effects on investor psychology, making markets less tolerant of monetary policy tightening that is seen as no longer justified,” IIF analysts wrote on Thursday. “The risk of a similar market tantrum (until 2018) is on the rise again now as markets fear a global recession.”

There were signs of a sense of resilience among investors. For example, the Cboe Volatility Index, known as Wall Street’s fear gauge, is high but lower than levels reached during the previous major sell-off.

Lieber’s data showed that the ARK Innovation Fund, which has become a symbol of the pandemic’s rise, has brought in net positive inflows of $977 million over the past six weeks. The fund fell 57% in 2022.

While some investors say these are signs that markets haven’t hit rock bottom yet, others are more optimistic.

Terri Spath, chief investment officer at Zuma Wealth, believes some investors are re-entering parts of the stock market that have suffered huge losses.

“The Fed is already seeing signs that it will not be needed as a buyer of last resort,” she said.

Analysts at Deutsche Bank are less optimistic.

“Having erred so badly on hyperinflation in 2020/21, the Fed cannot afford to make the same mistake twice – which favors further tightening of financial conditions, and (volatility) continuing to rise in panic markets,” they wrote.

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