Stocks Are Still Blinded To Risks By Rate-Cut Optimism

Authored by Simon White, Bloomberg macro strategist,

Animal spirits are regnant in stock world, as net positioning shoots higher this year. 

But the reason for the market’s expectation of imminent interest rate cuts – rising financial-instability risks - is also the reason more caution is warranted.

Stock investors have got off to an assertive start in 2024.

Aggregate positioning of speculators across major US equity indices has rocketed from net short to net long in only a few weeks.

The aggregate number is driven by net positioning for Dow Jones and Nasdaq futures, which are at their highest levels in at least two years. Net positioning in the S&P e-minis remains net short, but is rising.

Stock optimism has been boosted by the Fed’s pivot in December, and the market’s eagerness to out-dove the central bank by pushing for a rate cut as early as March.

[ZH: Fed's Waller pushed back the hardest yet on the market's March rate-cut odds expectations]

There have been several hypotheses put forward for this, such as a dovish read of recent economic data, or large yield-curve steepening positions upending short-term rate pricing. But none are particularly convincing.

However, through the prism of a rise in perceived financial-instability risks, pushing for a cut makes a more sense.

If that’s the case though, the zeal for equities could face a rude awakening.

That’s especially the case if the Fed forcefully pushes back on a March rate cut, and there is greater financial instability as quantitative tightening begins to bite harder, leading to potential funding flare-ups.

Stocks in such a situation would find themselves on shaky ground.