Goldman Sachs says the selling won't stop until this happens

Published Tue, May 24 20229:39 AM EDTUpdated Tue, May 24 202210:16 AM EDT

The current market downturn likely won't end until the Federal Reserve decides to reverse course on tighter monetary policy, according to Goldman Sachs. That likely won't happen, the firm argues, until the economy is either in a recession or showing signs that the Fed no longer needs to keep hitting the brakes. "The story this year has been a Fed-driven one, as the market has continued to steadily price in more Fed tightening this year while simultaneously worrying that this front-loaded tightening will lead to a reversal," Goldman strategist Vickie Chang said in a note to clients. "Using history as a guide, in order for equities to come off their recent lows (and stop declining), this kind of monetary-tightening induced contraction is most likely to end when the Fed itself shifts." There's no sign now that the Fed intends to change course from a policy aimed at taming surging prices that are running at a level not seen in more than 40 years . The central bank already has raised benchmark interest rates twice this year and is expected to approve a further series of hikes until it sees inflation moving closer to its 2% long-run target. Atlanta Fed President Raphael Bostic suggested Monday that the rate-setting Federal Open Market Committee might "pause" as early as September to see what impact the rate hikes are having, but that does not appear to be the consensus view. Markets have recoiled even though the tightening cycle is in its early stages. The tech-focused Nasdaq Composite Index has entered a bear market while the S & P 500 and Dow Jones Industrial Average are hovering around that area as well . Investors are looking for a capitulation point that may not come for a while, according to the Goldman analysis. "On average, monetary-policy-driven equity corrections have bottomed when the Fed has shifted towards easing, regardless of whether activity has troughed," Chang wrote. "In essence, when the source of the correction is known to be monetary tightening, a shift to monetary easing has provided fairly immediate relief as the market anticipates and trusts that the activity pickup will happen down the line." This Fed-driven market downturn differs from retreats that are triggered by a slowdown in business activity. Goldman examined 17 similar episodes since 1956 and concluded that there are differences between the two triggers. In market slides driven by declines in manufacturing, Fed policy doesn't have as much impact. But when markets are responding to a tighter Fed, it generally takes at least a signal that looser policy is coming until markets hit a trough that leads to a turnaround. "The market is unlikely to get a clear signal from the Fed until clearer signs of moderating growth and easing inflation pressures come into sight," Chang said. "There are some signs of each now, but neither is yet definitive." Goldman's economists see about a 1-in-3 chance for a recession happening in 2023. However, Chang said that if inflation shows signs of receding in the latter part of this year, that could be enough to anticipate a loosening in Fed policy that would provide relief for stocks.