According to Wolfe Research, investors are betting big against inflation in stocks that may not grow this year. The S&P 500 index is up nearly 5% this year, a move that comes as markets expect the Federal Reserve to end a rate hike that was designed to keep inflation in check. With market valuations suggesting the Fed is likely to raise its benchmark lending rate by half a percentage point or more, investors have become more comfortable with owning stocks. According to CME Group data, Fed fund futures even predict some mild rate cuts by the end of 2023. Analysts at Wolfe say that could be a mistake because the Chairman Fed Jerome Powell and other policymakers have vowed to be cautious when they believe inflation is falling. “We also believe that the market is underestimating the Fed Chair’s desire to avoid a 1970s-style resurgence in inflation,” the company said in a client note. “We think Powell will disappoint the market by maintaining a hawkish tone in his press conference on Feb. 1.” The 1970s saw the Fed raise interest rates to control inflation, but cut rates again when there were signs of economic weakness. That led to a more draconian rise in the early 1980s that plunged the economy into a double recession. Many Fed officials have vowed not to repeat those mistakes. Essentially, the markets are assigning a 100% probability to the Fed raising the fund rate by 0.25 percentage points between January 31 and February 31. 1 meeting of the Federal Open Market Committee. Futures pricing suggests another rate hike in March before the Fed pauses to assess the impact of the rate hike on inflation and the broader economy, particularly the labor market. That would bring the fund rate to a target range of 4.75%-5%, the highest level since October 2007. A sharp tightening in 2022 coincides with a near-term drop in the S&P 500. 20%. The Fed’s rate hike is essentially tightening financial conditions, of which stock prices are an important component. So a rising market is a sign that investors see an easier Fed along the way. Prices are rising despite widespread predictions that the economy will slip into recession at some point in 2023. “We primarily attribute the recent strong ‘risk-on’ rally to the markets. look past short-term economic weakness and towards the next Fed cut cycle – even though the current hiking cycle isn’t over yet!” Wolfe’s team wrote. While several Fed officials have confirmed in recent days that they expect a smaller rate hike, they also said they don’t expect any rate cuts at least until. 2023. “For U.S. markets, what’s new for 2023 is that the U.S. economy can avoid a deep recession because inflation is falling rapidly, allowing the Fed to end its rate-raising cycle early. interest rates and even lower rates at the end of the year,” DataTrek Research co-founder Nicholas Colas said in his daily note Monday night. “The opposite view: history also shows that the Fed cuts policy rates most often during recessions … and very little is known about the US economy that speaks of a ‘recession’ right now. .” Markets will get a better look at the economy on Thursday when fourth-quarter GDP numbers are released. The Fed will also see one more key data point ahead of its next meeting, the personal consumption expenditures price index, due for release on Friday. Core PCE is the Fed’s preferred measure of inflation. — Michael Bloom of CNBC contributed to this report.