The U.S. economy and the S&P 500 could crash unless the Federal Reserve takes action.

The most encouraging sign that a recession brought on by the Federal Reserve can be avoided in 2019 has been removed. Hourly pay was revised up in September and October, and then again in November, pushing wage growth well beyond the Fed's 2% inflation objective.

In practice, there is growing unanimity that the Federal Reserve raising its inflation target is the only way to keep the U.S. economy from crashing and the S&P 500 from falling much worse. It's possible the Fed would be open to doing so, but additional cooling is required before it would halt rate hikes.

RSM senior economist Joe Brusuelas told IBD that the 2% inflation target "is a lot more elastic than the Fed is letting on" because "I don't think there's any constituency out there for the bloodletting that would be necessary."

By Brusuelas's calculations, the Fed would have to raise the unemployment rate to 6.7% in order to get inflation back up to 2%. But a much more manageable increase to 4.6% unemployment would still sacrifice 1.7 million jobs and get us most of the way there (to a 3% inflation rate).

"If the Fed is hellbent on getting to 2% inflation, then that might demand additional rate hikes and a higher terminal rate than is already being baked into the cake," said Joe Quinlan, head of market strategy at Merrill & Bank of America Private Bank. Perhaps too much monetary tightening is to blame for the severe downturn in U.S. GDP and corporate profits that this has triggered.

In spite of this, Quinlan acknowledges the possibility of a more optimistic conclusion. He anticipates a market bounce if inflation keeps falling toward 3% and Fed policymakers "take their time," rather than pressing the issue.

"Two years from now, I wouldn't be astonished if the Fed set a new inflation target of 3% to 3.5%. Certainly that's doable, and it would be welcomed by all concerned."

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