Stocks may slump if banking fears choke growth - and the Fed should end its inflation fight, Wharton professor Jeremy Siegel says

• The Federal Reserve has already won its war against inflation, Jeremy Siegel says.
• The retired Wharton professor expects the recent banking chaos to hit lending and the wider economy.

The Federal Reserve is battling a non-existent foe, the banking turmoil is threatening to strangle the wider economy, and stocks are poised to slump in the weeks ahead, Jeremy Siegel has warned.

"The Fed's fight against inflation should be over," the retired Wharton finance professor declared in his WisdomTree commentary this week.

The Consumer Price Index climbed 5% over the last 12 months, putting the inflation benchmark well above the Fed's 2% target. However, Siegel noted that if you measure the pace of price increases using current housing data instead of the CPI's shelter component, inflation has been negative over the last nine months.

Moreover, the collapse of Silicon Valley Bank and Signature Bank in March could spook other lenders into pulling back and raising their standards to protect themselves against a sudden wave of withdrawals, Siegel said. Consumers and businesses might find it harder to borrow as a result, curbing economic growth and increasing the risk of a recession.

"These tighter lending conditions are doing work on inflation for the Fed and the Fed doesn't need to compound the slowdown any further with more rate hikes," he said.

In a bid to tame inflation, the US central bank has hiked rates from virtually zero to upwards of 4.75% over the past 13 months or so. Higher rates can cool price growth by encouraging saving over spending and making borrowing more costly. Yet they can also temper demand, drag down asset prices, and push the economy into a recession.

Retail sales and manufacturing data held up surprisingly well in March, Siegel said, suggesting demand is holding up for now.

"Friday's data basically indicates the economy is not falling apart yet, with yet being the keyword," he said. However, he noted the full impact of the banking chaos is yet to show up in most economic data.

The fallout from the financial stress and the Fed's rate hikes should become clear in time, and official inflation data should catch up with economic reality, Siegel said. If that happens soon, the central bank is likely to cut rates materially later this year, he continued.

Meanwhile, the author of "Stocks for the Long Run" cautioned the stock market may be nearing a peak if investors follow the famous investing adage and "sell in May and go away."

"I can see some further pressure in the short run," he said. "For now, it remains prudent to have a cautious near-term outlook on stocks, but I'm still very bullish longer term."

Siegel also flagged an uncertain outlook for regional banks, and predicted another rate hike in May would act as a "booster shot" and fuel further deposit flight to higher-yielding Treasuries and money-market funds.