The S&P 500's 2023 gain is set to be wiped out in a matter of weeks as the Fed's inflation fight remains 'very much unaccomplished,' says Bank of America

• The S&P 500's gain for the year is likely to be erased by early March, Bank of America says.
• The index could fall to 3,800, settling below last year's closing level.

The gains enjoyed by the S&P 500 in 2023 are likely to vanish soon with the Federal Reserve still in tightening mode even after a year of battling high inflation, Bank of America said in a note on Friday.

Anticipation that the world's largest economy may avoid a recession has helped push the S&P 500 up nearly 6% since the start of 2023 after last year's bear-market plunge. Friday's session put the index at 4,077, but the rally has been losing steam, with the index posting a second consecutive weekly loss.

"Be aware that the benchmark's advance so far this year is likely to be wiped out by early next month," Michael Hartnett, chief investment strategist at Bank of America Global Research, wrote in a note to clients on Friday.

The "failure to break 4.2k SPX ceiling means swoon to 3.8k by Mar'8th," he wrote. A level of 3,800 would represent a 6% drop from Friday's close. It would also put the S&P 500 below its 2022 close at 3,839.50.

Hartnett said his team is seeing a "crack" in stocks for homebuilders and semiconductor makers as well as in bank stocks in the US, Europe and Japan.

Key to the call is January economic data showing inflation has been slow to decelerate while consumers flexed buying power in an elevated inflationary environment.

"Payroll, retail sales, inflation; mission very much unaccomplished for Fed despite 450bps tightening," said Hartnett. The most aggressive Fed tightening in decades has resulted so far in retail sales surging, the unemployment rate moving to a 43-year low, payrolls rising by more than 500,00 in January and a reacceleration in wholesale and consumer price inflation from December, he said.

The Labor Department recently said the US economy added 517,000 jobs last month, blowing out expectations of 185,000 jobs.

Put together, the data keep pressure on the Fed to keep ratcheting up interest rates. Bank of America in a separate note from US economist Michael Gapen said it now sees the Fed raising the Fed funds rate by 25 basis points in June, which would bring the terminal rate to a target range of 5.25-5.5%.

Stocks dropped this week as the hotter-than-expected inflation readings propelled the 2-year Treasury yield, sensitive to Fed rate expectations, to a 2023 high above 4.7%.

Stubbornly high inflation also appeared to put a rate hike of 50 basis points in play for the Federal Open Market Committee's March 21-22 meeting.

This week, Cleveland Fed President Loretta Mester she saw "a compelling economic case for a 50-basis-point increase" when policy makers met this month, and that bigger rate hikes are not out of the question. St. Louis Fed President James Bullard said he wouldn't rule out policymakers returning to a half-percentage point hike in March.

The Fed downshifted the size of its rate hikes to 25 basis points in December and earlier this month, and Federal Reserve Chairman Jerome Powell recently said a "disinflationary process" was underway.

BofA's Gapen said the risk of a larger rate hike of 50 basis points is low as policy makers would need "concrete evidence" of re-acceleration and firming price pressures.

Hartnett said while the US economy may able to avoid recession in the first half of 2023, a "hard landing" is in store for both markets and the economy in the second half of the year.

The Fed funds rate is currently in the range of 4.5%-4.75%.