Wall Street Week Ahead: As bear market looms, battered Wall St seeks elusive ‘Fed put’

NEW YORK: 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 US 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 market tantrum.

This time around, the Fed’s 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&P’s Jan. 3 closing high.

The index, which was recently at 3,840, is already down around 20% from that high this year on an intraday basis - putting it on track to 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. BofA’s survey showed cash allocations at a two-decade high, while bets against technology stocks stand at their highest since 2006.

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 downside.” The S&P 500 was recently down 1.5% on Friday, on track for its seventh straight week of losses.

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.