- The Federal Reserve is "desperately behind-the-curve" after inflation jumped 7.5% in January, Bank of America said.
- The bigger-than-expected jump in inflation has led to surging probabilities that the Fed might do an emergency rate hike this month.
- "Aggressive Fed at moment of overvalued asset markets not normally recipe for big returns," BofA said.
Inflation is higher in America than it is in Mexico, and yet the Federal Reserve maintains a fed funds rate of 0% while Mexico's central bank rate stands at 5.5%.
That's just one anecdote used by Bank of America to highlight that the Fed is "desperately behind-the-curve," according to a Friday note.
With CPI data showing a 7.5% jump in prices in January, inflation is at its highest level since 1982. Food prices were up 20% year-over-year, while rent and energy prices were up 10%-20% and 40%-50%, respectively. "Call it what you will, [but inflation] ain't transitory," BofA said.
Yet instead of tightening monetary conditions in the face of rising inflation, the Fed is still easing, having bought about $200 billion worth of bonds over the past month, according to BofA.
The juxtaposition of sky-high inflation with rock bottom interest rates doesn't make sense to BofA, and something has to give. With the market favoring interest rate hikes, the probability of an emergency Fed rate hike in February surged to about 30% on Thursday after Fed president James Bullard said he favored a 50 basis point hike in March.
And with the Fed set to aggressively hike interest rates in the first half of 2022, stock market investors likely need to lower their expectations after years of double digit returns.
That lines up with commentary from Goldman Sachs, who said in a Thursday note that investors need to reposition their portfolio for a regime change in the stock market that favors value sectors like energy and financials.
That said, BofA stressed that "tops are a process" and there's no reason why the economy will immediately dive lower as the Fed remains accommodative and even a few interest rate hikes would still leave rates sitting near historic lows.
Additionally, carnage below the surface of the stock market has been "savage" BofA said, noting that 46% of all Nasdaq companies were more than 50% below their 52-week highs a week ago.
Still, the bank doesn't see a "Fed put" triggering — code for when the Fed will engage in a series of policy easings after a large stock market decline – unless the S&P 500 reaches the 3,800-4,000 range, representing potential downside of up to 16% from current levels.
"Aggressive Fed at moment of overvalued asset markets not normally recipe for big returns," BofA said.