The S & P 500 has fallen about 12% so far this year amid soaring inflation, war in Ukraine and tighter Fed policy. Historically, the market could count on the Federal Reserve to step in with easy policy to help limit big losses in equities, which has been known since the days of former Fed Chair Alan Greenspan as "the Fed put." But with inflation now running at 40-year highs, the central bank is committed to tightening monetary policy to fight it. On Wednesday it raised the benchmark Fed Funds by half a point. In this world, the Fed may be willing to take more market pain before easing up, Citi analysts said in a report Wednesday. "High inflation constrains the Fed, making easing monetary policy less likely if growth (or markets) fall," Citi analyst Alexander Saunders said in the note. "We have long argued that elevated inflation would put the Fed in a bind — when growth weakens they would not be willing to or able to ride to the rescue by loosening monetary policy." U.S. 10-year Treasury rates tend to move lower after 10% stock market corrections, but in cases of high inflation, those cuts by the Fed take longer to arrive, the note said. Data studied by Citi's analysts suggest the Fed could wait for the S & P 500 to sink to the 3,800 level, or 9% below Tuesday's close, before considering taking its foot off the brakes. In the 1970s and in 1987, the drawdowns were even larger, at about 30% from their 12-month highs, the note said. "We look at how far markets might have to fall to see the Fed react, and find it could be 20% or more from current levels in the worst case," Saunders said. When inflation is below 3.5%, cuts have happened within 10 days of a market drawdown. However, headline inflation rose 8.5% on a yearly basis in March, and the Fed typically reacts later to equity drawdowns when inflation is high, Saunders said in the note. That also means stocks recover more slowly. Because the current hiking cycle is just starting, a "Fed put" could translate into just a slower pace of rate hikes, rather than any move to keep down rates, Saunders said. The market is expecting the sharpest hiking cycle in decades, and Citi economists call for 200 basis points of hikes over the next four Fed meetings. "With inflation expected to remain elevated in the near-term, any action due to worsening financial conditions is unlikely to result in a pivot towards monetary accommodation," Saunders concluded.
