Is the December Cut Already Priced In?A Playbook for Trading the Next Fed Move.

Executive Summary

Heading into the December 9–10 FOMC meeting, the market has all but decided:

• Probabilities implied by Fed funds futures and options put the odds of a 25 bp cut around 85–87%.
• Meeting-dated pricing implies roughly 21–22 bp of easing — meaning the cut itself is largely priced in.

The real question isn’t Will they cut? It’s: Has the market over-priced a smooth, dovish easing path beyond December — and how do you trade that asymmetry?

In this report:

• We argue the December cut is mostly in the price, with only a few basis points of incremental upside if the Fed is cleanly dovish.
• The forward path — roughly 3–4 cuts (75–100 bp) implied into late 2026 — is where the market is more optimistic than the Fed.
• The right move is a hedged, multi-asset playbook:
  • defined-risk front-end upside if the Fed leans dovish,
  • convex insurance against hawkish outcomes,
  • curve and sector trades that express the regime, not just the headline.

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At a Glance

• Current policy rate: Around 3.75–4.00% after prior cuts and QT slowing/halting.
• December cut odds: Roughly 85–87% probability of a 25 bp cut, 13–15% probability of no change.
• Implied path: Front-end curves and options imply roughly 75–100 bp of total easing (3–4 cuts) through late 2026.
• Curve shape:
  • 2s10s spread ≈ +0.55%, having flipped from inversion to positive territory around +0.50% in late October.
• Risk assets:
  • Homebuilders (XHB): roughly +15–16% over the last 6 months, even after a –4–6% pullback over the last 3 months.
  • Gold (GLD): about +16% over 3 months, and roughly +45–60% over 12 months depending on the measure.

This is a market that has already re-priced for lower policy rates, a soft landing, and a Fed that will “manage” the cycle.

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The Setup: From Emergency Mode to Calibration

The Fed’s journey this cycle:

1. Shock tightening: rapid hikes to crush post-pandemic inflation.
2. Initial cuts: as inflation rolled over and growth cooled.
3. Calibration / risk-management: fine-tuning the stance around neutral, while watching both inflation and growth risks.

Going into December:

• Policy is off the peak but still restrictive in real terms.
• Inflation is trending lower, but core services and wages are still above comfort.
• Growth has slowed from “above trend” to something closer to “trend-ish,” with no hard landing in the data yet.
• Funding markets occasionally flash amber but are not in crisis territory.

This backdrop argues for risk-management cuts, not for a pre-announced easing cycle.

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What the Market Is Pricing In

1. The December Meeting

The front end is saying:

• Odds of a December 25 bp cut: ~85–87%.
• Implied move in meeting-dated Fed funds: ~21–22 bp lower than “no change”.

That leaves:

• 3–4 bp of upside if the Fed delivers a textbook dovish cut and the market squeezes toward a full 25 bp.
• 20–30 bp of downside if the Fed surprises hawkishly or holds.

Conclusion: The cut itself is largely priced in. The event still matters, but most of the mechanical rate move is already embedded.

2. The Forward Path (2026)

The more fragile piece is the path beyond December:

• Front-end forwards and options imply roughly 3–4 cuts (75–100 bp) over the next 12–18 months, pushing the funds rate toward the low-3s by late 2026.
• That is a soft-landing + gentle easing story: inflation glides down, growth slows but avoids recession, and the Fed slowly hands back restrictive policy.

Fed rhetoric, in contrast, has been:

• Explicitly data-dependent.
• Emphasizing two-sided risks (inflation vs growth).
• Careful not to pre-commit to more than the next step.

So the market’s path is cleaner and more dovish than the Fed’s own message.

3. Curve and Risk Assets

The curve:

• 2s10s spread has gone from deep inversion to around +0.55%, a clear regime shift from “ongoing tightening” to “cuts coming.”

Risk assets:

• Homebuilders (XHB, ITB) have rallied double-digits on a 6–12 month horizon, even after a few percent pullback.
• REITs (VNQ, IYR) and utilities (XLU) have benefited from lower rate expectations.
• Gold (GLD, IAU) has surged, reflecting lower real rate expectations plus macro hedging demand.

Rates, the curve, and risk assets are all saying the same thing: the easing story is well-owned.

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Has the Market Over-Priced the Cut?

On the Meeting Itself

With around 21–22 bp implied:

• A 25 bp cut with mild dovish color gives you maybe 3–4 bp of additional front-end rally.
• A dovish cut that clearly flags more easing could give you 5–10 bp.
• A hawkish cut or hold can easily force 20–30 bp of repricing higher.

So:

• The cut is largely but not insanely priced in.
• Directional long-duration bets into the event have poor asymmetry.

On the Path and the Narrative

Where over-pricing is more likely:

• The market assumes the Fed will be willing to deliver 3–4 more cuts despite still-sticky services inflation and only slow-bleed labor softening.
• Term premium and Treasury supply can push long rates higher even if the Fed is cutting at the front end.
• A modest upside surprise in inflation or growth can easily justify a “one-and-pause” stance rather than a mini-cycle.

So the December cut is “just” expensive; the full easing path is vulnerable.

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Scenario Map: Four Paths Out of December

Scenario	What Happens	Prob.	Front-End Move vs Now	Narrative	Market Reaction Bias
Hawkish cut	-25 bp, guidance stresses data dependence and high bar for further cuts	~40%	0 to +5 bp	“One-and-pause”	2–5Y underperform, mild bear-flattening, risk assets wobble but avoid full risk-off
Dovish cut	-25 bp plus clear openness to more easing in 2026	~35%	–5 to –10 bp	“Soft landing + gentle easing”	Front-end rally, bull steepener, XHB/VNQ/XLU and GLD extend gains
Dovish hold	No cut, but strong signal of likely cuts at upcoming meetings	~15%	+20–25 bp	“We’re close, just not today”	Short-end sells off, then partially retraces; rates vol spikes
Hawkish hold	No cut; dots/path hint that cuts may be done for now	~10%	+20–30 bp	“We may be done cutting”	Sharp front-end selloff, bear-flattening, risk assets de-rate, stronger dollar

The asymmetry:

• Upside from a dovish cut: 5–10 bp and incremental risk-on.
• Downside from hawkish outcomes: 20–30 bp of wrong-way move plus cross-asset pain.

This is a hedging setup, not a “bet the farm on dovishness” setup.

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Risk Dashboard: Data and Markets That Matter

Some concrete markers to track:

• 2s10s spread: around +0.55%; a move back toward +20–30 bp would signal a hawkish or term-premium shock.
• 2Y yield: around 3.5%; dovish cut could push it to 3.3–3.4%, hawkish outcomes toward 3.8–4.0%.
• GLD: roughly +16% over 3 months, +45–60% over 12 months — a lot of easing/policy anxiety already embedded.
• XHB: around +15–16% over 6 months, mildly negative over 3 months — a sector that has already “banked” lower rates once.

Macro data to watch:

• Core inflation and wage prints between now and the meeting.
• Labor data (payrolls, unemployment rate, claims).
• Term premium / Treasury auctions and long-end yield behavior.
• Funding markets for signs of stress or tightness.

Any combination of hotter inflation, resilient labor, and sticky long yields tilts the Fed toward hawkish cut or hold. The opposite tilts toward a dovish cut.

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The Playbook: How to Trade or Hedge the December Cut

(With Actual Instruments)

1. Core Rates View – Defined-Risk Call Spreads

Goal: Monetize the last 3–5 bp of dovish upside without getting crushed if the Fed under-delivers.

Institutional / futures

• Underlying:
  • CME 3-Month SOFR Futures – SR3 (e.g., SR3Z5, SR3H6).
• Options:
  • CME SOFR options – O3S.

Example:

• Buy SR3H6 96.25 calls
• Sell SR3H6 96.50 calls

A bull call spread that:

• Wins if the March SOFR contract rallies another ~10–12 ticks (≈2.5–3 bp) beyond what’s already implied.
• Costs limited premium, aligned with the 3–5 bp of upside that still exists.

Alternative:

• 30-Day Fed Funds futures – ZQ plus options on the meeting-dated contract.

ETF / listed proxy

If you don’t trade SR3/ZQ:

• Work with short-duration Treasury ETFs:
  • SHY – iShares 1–3 Year Treasury Bond ETF
  • IEI – iShares 3–7 Year Treasury Bond ETF

Proxy:

• Buy slightly ITM 1–3 month calls on SHY or IEI.
• Sell OTM calls above to create a spread.

Target: ≤0.3% of portfolio NAV in premium for this leg.

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2. Hedge the Hawkish Surprise – Front-End Payer Optionality

Goal: Protect against the 10–25% chance that the Fed doesn’t validate the easing path (hawkish cut or hold).

Institutional / OTC

• Instrument:
  • 1M payer swaptions on 2-year or 3-year USD swaps, struck ATM or slightly OTM.

If the market has to remove 25–50 bp of implied cuts:

• 2–3Y swaps jump.
• Payer swaptions pay off with convexity.

ETF / listed proxy

Use puts on Treasury ETFs:

• IEI – 3–7Y Treasuries
• IEF – 7–10Y Treasuries

Example:

• Buy 1–2 month ATM or 2–3% OTM puts on IEI or IEF.

Target: another ≈0.3% of NAV in premium for hawkish insurance.

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3. Curve Trades – Trade the 2s10s Shape

Goal: Express whether the curve stays around +50–60 bp, steepens, or re-flattens.

Futures

• 2Y leg: CME 2-Year Treasury Note – ZT
• 10Y leg: CME 10-Year Treasury Note – ZN

Bull steepener (base case: soft landing + gentle easing):

• Long ZT / short ZN, DV01-matched.
• If a dovish cut takes 2Y yields from ~3.5% to ~3.3% while 10Y drifts only slightly, the 2s10s can push toward +70–80 bp.

Bear-flattener (if you fear hawkish / term-premium shock):

• Short ZT / long ZN, DV01-matched.
• If 2Y pops to ~3.8–4.0% while 10Y stays anchored, 2s10s can shrink back toward +20–30 bp.

ETFs

• Short-end proxy: SHY
• Long-end proxy: IEF or UST

An ETF steepener:

• Overweight SHY vs IEF (or long SHY / short IEF).

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4. Equity Tilt – Rate-Sensitives with Index Protection

Goal: Lean into sectors that like lower rates, while hedging the index.

Sector tilts

• Homebuilders / housing:
  • XHB – SPDR S&P Homebuilders ETF
  • ITB – iShares U.S. Home Construction ETF
• REITs:
  • VNQ – Vanguard Real Estate ETF
  • IYR – iShares U.S. Real Estate ETF
• Utilities:
  • XLU – Utilities Select Sector SPDR

Implementation:

• Add incremental exposure to XHB/ITB, VNQ/IYR, XLU on dips into (and just after) the meeting.
• Fund by trimming areas less sensitive to rates or more stretched on valuation.

Index hedge

• SPX or SPY options:
  • Buy 1–2 month put spreads:
    • Long ~5–10% OTM put;
    • Short a further OTM put to defray cost.

Target: ≈0.5% of NAV premium for index protection.

If the Fed is dovish, your rate-sensitives do the work. If the Fed disappoints, the index hedge softens the blow.

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5. FX and Gold – Cross-Asset Ballast

Gold

With GLD already up strongly over 3 and 12 months, it’s not “cheap,” but it is still useful ballast:

• 3–5% allocation in:
  • GLD – SPDR Gold Shares
  • IAU – iShares Gold Trust

Or:

• 3–6 month GLD call spreads
  • Long ATM/slightly ITM calls,
  • Short higher-strike OTM calls.

Gold tends to like:

• Lower real yields,
• Policy uncertainty,
• Macro/geopolitical stress.

FX – USD/JPY Example

• Futures: 6J – CME Japanese Yen.
• Spot: USD/JPY via FX broker.

If the Fed cuts and sounds dovish while the BoJ edges away from ultra-easy policy, USD/JPY has downside risk (yen strength).

Example hedge:

• Long 1M 6J call spreads (benefits from yen strength).
• Or USD/JPY put spreads in spot.

Small size here; think of it as tail insurance, not a core macro bet.

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Mini Playbook – A Concrete Package

For a professional / multi-asset book, a coherent setup could be:

• Front-end dovish expression:
  • SR3H6 call spreads (O3S), or SHY/IEI call spreads.
• Hawkish insurance:
  • 1M payer swaptions on 2–3Y swaps, or 1–2M puts on IEI/IEF.
• Curve:
  • Modest bull steepener via long ZT / short ZN.
• Equities:
  • Overweight XHB/ITB, VNQ/IYR, XLU;
  • Hedge with SPX/SPY put spreads.
• Cross-asset ballast:
  • 3–5% in GLD/IAU plus a small JPY-bullish (6J call spread) tail hedge.

For a simpler / semi-retail portfolio:

• Focus bond exposure in SHY / IEI rather than maxing out duration.
• Add some XHB, VNQ, XLU around the event.
• Use small SPY put spreads as a straightforward hedge.
• Keep a small gold ETF sleeve as macro insurance.

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Risk Management: Numeric Guardrails

• Total options premium:
  • Keep event-driven premium around 1–1.5% of NAV in aggregate.
• Rates DV01:
  • Size so a 25–30 bp wrong-way move in the 2–3Y area is painful but not existential.
• Timing discipline:
  • Treat these as event trades: scale down or exit most of them within 1–3 trading days after the FOMC, unless a new regime is clearly underway.
• Pre-Fed flexibility:
  • If implied cut odds lurch from ~85–87% toward, say, 60% or 95+% before the meeting, rebalance your package instead of clinging to the original setup.

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Bottom Line

• By the numbers, the December cut is largely priced in: high-80s probabilities, 21–22 bp embedded, curve already normalized.
• The benign easing path into 2026 — three to four additional cuts, neatly sequenced — is where the real risk lies.
• The edge isn’t in guessing the headline; it’s in structuring a portfolio that benefits from either tail and survives the middle.

Let everyone else argue about whether the odds are 83% or 87%. Your edge is a hedged, multi-layered playbook: defined-risk upside, convex protection, curve and sector expressions, and cross-asset ballast — all sized so that a 25 bp decision doesn’t blow up a 25-year plan.

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Disclaimer: This report is for informational and educational purposes only and does not constitute investment advice or a recommendation to buy or sell any security, derivative, or instrument. Markets involve risk, including the risk of loss of principal. Always consider your objectives, risk tolerance, and local regulations, and consult a qualified advisor before implementing any strategy.