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

Traders work at the New York Stock Exchange (NYSE) in New York City, U.S., March 21, 2022. REUTERS/Brendan McDermid

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NEW YORK, May 20 (Reuters) – The Federal Reserve’s determination to raise interest rates until it suppresses the highest inflation in decades has dimmed the outlook for Wall Street as a whole as U.S. stocks are on the cusp of a bear market and fears of a recession. The warnings are getting louder and louder.

The problem is so-called Fed put options, or investors’ belief that the Fed will act if the stock market falls too far, even if it doesn’t have the mandate to maintain asset prices. An oft-cited example of this phenomenon, named for a hedge derivative used to protect against market declines, occurred when the Federal Reserve stopped its rate-hike cycle in early 2019 after the stock market tumbled.

This time around, the Fed has insisted on raising rates as high as it needs to to tame soaring inflation, bolstering the argument that policymakers are less sensitive to market volatility — adding more pain to investors.read more

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Fund managers now expect the Fed to step in at 3,529 points in the S&P 500, according to a recent survey by BofA Global Research (.SPX), compared with expectations for 3,700 in February. Such a decline would be 26% below the S&P’s Jan. 3 closing high.

The index closed Friday at 3,901.36, having fallen nearly 19% from this year’s high intraday — close to the 20% drop that would confirm a bear market by some definitions.

“The Fed has a bigger fish to play, and that’s the inflation issue,” said Phil Orlando, chief equity market strategist at Federated Hermes, who is increasing cash levels. “The ‘Fed put’ has expired before the central bank is confident they are no longer behind the curve.”

So some investors are digging for the long haul. Cash allocations are at their highest level in two years, while bets on tech stocks are at their highest since 2006, the Bank of America survey showed.

Meanwhile, Goldman Sachs strategists released a “U.S. Equity Recession Playbook” earlier this week in response to client inquiries about the performance of stocks in a downturn.Barclays analysts said the multitude of negative near-term catalysts meant that risks to stocks “remain firmly stacked on the downside.” Read more

The S&P 500 closed largely flat on Friday, reversing a steep intraday decline that had once entered bear market territory. The index fell for a seventh straight week, its longest losing streak since 2001.

With unprecedented monetary policy support helping stocks more than double from their March 2020 lows, the Fed needs to drop at least another 15% to slow its pace of tightening, according to Jason England, global bond portfolio manager at Janus Henderson Investors.

“The Fed is 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. /FEDWATCH Investors will dig deeper into the central bank’s thinking when the minutes of its last meeting are released on May 25.

Comeback in 2018?

Some worry that the Fed could increase volatility if it does not heed possible red flags in asset prices. Analysts at the Institute of International Finance said stocks could suffer the same type of sell-off that rocked markets in late 2018, when many investors believed the Fed’s tightening of monetary policy was going too far.

“In the past, rising uncertainty and rising recession risks have had a significant impact on investor psychology, making markets less tolerant of monetary policy tightening that is no longer seen as a priority,” IIF analysts wrote on Thursday. “Necessary.” “The risk of a similar market panic now (in 2018) is rising again as the market fears a global recession.”

There are signs that investor sentiment has picked up.For example, the CBOE Volatility Index (.VIX)Known as Wall Street’s fear gauge, it rose but was below levels reached during previous major sell-offs.read more

ARK’s innovation fund ARKK.K, which has become a symbol of the pandemic rebound, brought in $977 million in net positive inflows over the past six weeks, Lipper data showed. The fund is down 57% in 2022.

While some investors say these are signals that the market has not yet bottomed, others are more hopeful.read more

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 has seen signs that they will no longer need to be the buyer of last resort,” she said.

Analysts at Deutsche Bank were less optimistic.

“The Fed made a serious mistake with hyperinflation in 2020/21 and cannot repeat the same mistake – which favors further tightening of financial conditions and continued high (volatility) panic markets,” they wrote.

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David Randall reporting editors Ira Iosebashvili and Matthew Lewis in New York

Our standard: Thomson Reuters fiduciary principles.

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