Wall Street analysts say the Fed is unlikely to surprise

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Wall Street analysts say the Fed is unlikely to surprise

The stock-market selloff is even more severe than it looks on the surface, setting a low bar for a positive surprise from the Federal Reserve when it ends its policy meeting Wednesday, according to analysts at JPMorgan Chase Co.

In a Wednesday note, strategists led by Dubravko Lakos-Bujas said the Fed is likely to strike a more dovish tone when it comes to extreme investor expectations, which could trigger an equity rebound.

Some market watchers have sounded a similar tune in the past few days. It isn't that the Fed is going to alter its tune to respond to market volatility, but rather that investors have penciled in the most aggressive path for Fed tightening, leaving room for a surprise.

Expectations are so hawkish at this point, and we believe the bar for a positive surprise from the Fed at the current juncture is fairly low, according to analysts at JPMorgan.

Related: Stock-market investors can't count on the Fed put - why policy makers aren't seen rushing to rescue.

The JPMorgan analysts noted that investors are expecting a total of eight rate hikes and a balance sheet reduction of around $1.2 trillion by the end of 2023.

The analysts said that there should be a balance between data dependency and willingness to revisit policy if inflation growth outlook softens compared to Fed being on autopilot. With high frequency economic data slowing last 2 -- 4 weeks, fiscal impulse turning negative and weakening 1 Q GDP could give the FOMC Federal Open Market Committee some reason for caution.

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The January drop in stocks appeared to catch the analysts by surprise. Lakos-Bajas and the team wrote in late December that conditions for a large selloff weren't in place given low investor positioning, record buybacks, limited systematic amplifiers and positive January seasonals. Need to know: It is Jerome Powell time and one Wall Street bank warns that the S&P 500 could fall another 20%. Goldman Sachs believes that the bull market will continue.

The analysts wrote Wednesday that the sharp drop that occurred is even more severe than it appears on the surface. The S&P 500 SPX, has traded this week below, but hasn't finished under, the threshold that would mark a 10% fall from its Jan. 3 record close and meet the technical definition of a market correction.

The Nasdaq Composite COMP has fallen into correction territory, while the Dow Jones Industrial Average DJIA was 6.8% off its Jan. 4 record close on Tuesday. The Russell 2000 RUT ended Tuesday 18.5% less than its all-time high finish.

The average stock in Russell 3000 RUA is down 35%, while the average stock in the growth-heavy Nasdaq Composite COMP is down almost 50%, according to the analysts. The drawdown in the S&P 500 is masking the severity of the selloff because of the exposure to bond proxy stocks and low volatility equities, they wrote, noting that low-vol stocks are trading at a record premium.

The stock market is not only in correction, but it is already in bear market territory, without a recession in sight, they said.

The selloff appears overdone in the short term, and the analysts wrote that it is a bullish setup, particularly for small-cap stocks heading into the Fed policy statement and month-end rebalancing.