Unless the Fed Does This, the U.S. Economy and S&P 500 Will Crash

The main reason to be optimistic about avoiding a Fed-induced recession next year was removed. Pay raises in September, October, and November pushed wage growth above the Fed's 2% inflation objective.

The only way the U.S. economy can escape a hard landing and a greater loss for the S&P 500 is if the Fed raises its inflation objective – at least in practice. The Fed may be inclined to stop raising rates, but additional cooling is needed.

RSM chief economist Joe Brusuelas told IBD that the 2% inflation target "is a lot more elastic than the Fed is letting on"

Brusuelas says the Fed must raise unemployment to 6.7% to restore 2% inflation. Getting to 3% inflation would require a jump in unemployment to 4.6%, costing 1.7 million jobs.

"If the Fed is hellbent on 2% inflation, that may need more rate hikes and a higher terminal rate," said Merrill & Bank of America Private Bank's Joe Quinlan. "There may be too much monetary tightening," causing a U.S. economic and earnings recession.

Quinlan also sees bullish potential. If inflation falls below 3% and Fed policymakers "take their time," stocks should rise.

"In two years, the new Fed inflation target might be 3% to 3.5%. All sides agree that's possible."