The stock market is about to see a 10% correction, with further disinflation a 'pipe dream' and Fed rate cuts coming much later, Stifel says

Inflation falling further from here in the near term is a "pipe dream" and rate cuts will continue to be pushed out, Stifel strategists said.

• The S&P 500 could fall around 500 points in a swift correction, Stifel strategists warned.
• The investment firm said falling inflation was a "pipe dream," and Fed rate cuts could be delayed.
• Markets see just one or two rate cuts by the end of the year, per the CME FedWatch tool. 

The S&P 500 could be on the verge of a sharp move down, as inflation isn't cooling much further from here, according to Stifel analysts.

In a note, the investment firm predicted the S&P 500 would fall to 4,750 in the second or third quarter of this year. That implies around a 10% decline from the benchmark index's current levels at around 5,222 on Monday.

Inflation will likely remain stubbornly high, the strategists predicted, as the economy is coming out of what they described as a "pseudo-recession" that took place from early 2022 and lasted through the middle of 2023. That accounted for the bulk of the disinflation seen to date, and economic activity has since revved up. 

"We have been wary of a broad S&P 500 correction in the middle quarters of 2024. While most strategists were expecting a recession last year or eagerly attempting to call the start of one in the next year, we have been of the view that the ~5 quarters 1Q22 to 2Q23 were a 'pseudo-recession' and the Fed has already harvested all the normal post-recession disinflation we would expect," the firm wrote.

Inflation still remains well above the Fed's 2% target. Consumer prices grew 3.5% year-per-year in March, the third straight month of hotter-than-expected inflation.

Elevated prices could be attributed to a still-hot economy, which is stoking price growth, strategists said. Hiring activity, for instance, remains robust, which can stoke wage growth and therefore raise inflation.

"As a result, the sustained 2% Core PCE inflation the Feed seeks is a pipe dream. With rates normalized and the mid-2024 pop in Core PCE to just over 3% that our models indicate we expect Fed rate cuts to be pushed back further, causing a middle quarters correction for equities," strategists added. 

Markets have already dialed back their outlook for Fed rate cuts this year, which drove a sell-of in stocks in April. Fed officials have said they're looking for more evidence that inflation is falling back to its 2% price target, and investors are now just expecting one or two rate cuts by the end of the year, according to the CME FedWatch tool, compared to six at the start of 2024. 

Traders are waiting for April inflation data to roll out this week, but central bankers are largely expected to keep interest rates at their current levels. Markets have priced in a 96% chance rates will be kept level at the Fed's next policy meeting, and a 75% chance rates will stay the same all summer.