The S&P 500 will plunge 11% by the end of 2022 as 'inflation shock' sparks a recession, Bank of America says

Bank of America said in a Friday note that investors are in for a world of pain in the year 2022, as an inflation-caused recession will spark another correction in the stock market.

According to the note, BofA stated bluntly that inflation causes recessions, and right now, inflation is out of control.

Inflation has been running hot as consumers demand more and as supply chain disruptions and a spike in commodity prices occur due to Russia's invasion of Ukraine. Prices have not been this high in over 40 years.

The last dominos to drop in terms of recession expectations are higher yields and a weaker dollar.

The note states that after the inflation shock, the rates shock will lead to a recession. According to BofA, the S&P 500 will fall below the 4,000 level by the end of 2022, representing a potential downside of 9% from current levels.

The Federal Reserve plans to raise interest rates by 50 basis points in May, according to this week's Federal Reserve minutes. The Fed plans to reduce its balance sheet by 95 billion dollars per month later this year.

The Fed's balance sheet had ballooned to $9 trillion from pre-pandemic levels. BofA said that quantitative tightening is the opposite of quantitative easing.

Quantitative easing was bullish for financial assets. BofA explained that quantitative tightening will be negative for financial assets. The Fed has been buying fixed income securities over the past two years in order to give the credit markets a boost. Buying pressure and pushing prices higher is created by that liquidity boost.

BofA said that the new era of Fed that suddenly now wants to address issues of wealth inequality starts with overvalued stock market.

Bill Dudley, the former Fed President, said in an Op-ed earlier this week that the Fed needs to cause pain in the stock market to help rein in inflation.

Dudley said that the Fed will have to impose more losses on stock and bond investors than it has so far.

If the S&P 500 falls to new lows this year, it will serve as a significant whiplash for investors, but it will also line up with a more than 100 year old bear market indicator that is prompting many traders to get serious about a potential recession.