Why the ‘pain trade’ of 2024 could reverse stock and bond market gains

“The market is an average of participants’ views and, caught between outcomes, appears to be pricing in a soft landing with ~140bp of cuts in 2024,” the team wrote in a Wednesday client note.

The team at GlobalData TS Lombard argues that the roughly 200 basis points of rate cuts currently priced in for the entire easing cycle might even be “too minimal than too aggressive,” especially if the economy sees a hard landing.

But the main issue “is not the magnitude of cuts,” the team said, but rather the optimistic moves in markets recently in anticipation of a batch of relatively early rate cuts this year.

“Thus, as we have seen at the start of 2024, the pain trade could be that we do not get priced-in cuts — undoing the 4Q23 price action of a weaker dollar, stronger FI and stronger equities.”

The Dow Jones Industrial Average
DJIA
rallied in the fourth quarter to set a series of record closes coming into the new year, while the S&P 500 index
SPX
ended Wednesday on the doorstep of its first record close in two years, according to Dow Jones Market Data.

In fixed income, the 10-year Treasury yield
BX:TMUBMUSD10Y
eased back to about 4% in the new year, after surging to a 16-year high of 5% in October. The threat of suddenly higher borrowing costs for much of the U.S. economy jolted stocks lower, and briefly erased earlier gains in the year for major U.S. bond benchmarks.

The closely tracked Bloomberg U.S. Aggregate index was up 2.41% on a one-year return basis, with the related iShares Core U.S. Aggregate Bond ETF
AGG
on pace for a similar return, according to FactSet data.

“Here there is certainly a risk of a further sell-off if Fed dovishness is reassessed,” the strategists wrote.

For currencies, the ICE U.S. dollar index
DXY,
a measure of the greenback against a basket of rival currencies, is down 3.5% over the past three months, according to FactSet data, despite logging its best first four days in a new year in nearly a decade.

The dollar in 2022 surged to its highest levels in two decades as the Fed was raising its policy rate, but a pivot to rate cuts could see it weaken further.

“The consensus is that the dollar will weaken in 2024 on the basis of significant Fed cuts,” Koning and Cicione wrote, adding that their forecast is for modest upside for the dollar.

A weaker dollar can help boost revenue at major U.S. companies relying on sales overseas, helping to offset today’s higher borrowing costs. But Fed rate cuts also could make assets pegged to the dollar less attractive to investors seeking yield.