The Case for Positioning in Risk-Asset Markets Ahead of the Fed's December Rate Cut

The Federal Reserve's December 2025 meeting has become a focal point for investors navigating a pivotal shift in monetary policy. With the central bank poised to cut the federal funds rate by 25 basis points to a range of 3.75% to 4%, the market is recalibrating its expectations for risk assets. This decision, driven by a weakening labor market and persistent inflationary pressures, underscores the Fed's dual mandate of balancing employment and price stability. As of late November, the CME FedWatch tool priced in an 85% probability of a December cut, though this figure has since fluctuated amid growing uncertainty about economic data and internal FOMC divisions. For investors, the implications are clear: strategic capital allocation in risk-asset markets is warranted ahead of this pivotal policy shift.

The Fed's Dilemma: Data Gaps and Divergent Views

The Fed's December decision is being made against a backdrop of incomplete data. The government shutdown delayed the release of October 2025 economic metrics, leaving policymakers reliant on stale September data. Retail sales in September rose by 0.2%, below expectations, while the Producer Price Index (PPI) showed a 0.3% monthly increase, reflecting lingering wholesale inflation. Employment data, however, painted a mixed picture: nonfarm payrolls rebounded with 119,000 jobs added in September, but the unemployment rate edged up to 4.4%, the highest since October 2021. These conflicting signals have deepened the divide between "hawks" and "doves" within the FOMC. Vice Chair Philip Jefferson has urged caution, emphasizing the risk of inflation remaining above target, while Governor Christopher Waller has advocated for further easing, citing labor market slack and tariff-driven inflation.

This internal debate has created a policy vacuum, with traders hedging their bets using rate derivatives. Open interest in SOFR options expiring in early 2026 has surged, and volatility in long-dated swaptions has spiked, reflecting heightened uncertainty. J.P. Morgan Research projects two additional cuts in 2025 and one in 2026, bringing policy rates to 3.5% by mid-2026. This trajectory suggests a prolonged easing cycle, which historically has favored risk assets.

Strategic Allocation: Equities, Fixed Income, and the Yield Curve

Major financial institutions are already positioning portfolios to capitalize on the Fed's anticipated rate cuts. J.P. Morgan's 4Q 2025 Global Asset Allocation report recommends a pro-risk tilt, emphasizing equities while maintaining a near-neutral stance in credit due to tight spreads. The firm highlights the U.S. yield curve's potential to steepen, with short-term rates (3-month to 2-year maturities) expected to decline sharply as the Fed cuts, while long-term rates (e.g., 10-year Treasuries) may remain anchored above 4% due to fiscal deficits and sticky inflation. This divergence creates an attractive opportunity in the 2–5-year part of the curve, where investors can capture both duration and yield.

UBS Market Know-How 4Q 2025 similarly advocates for diversified portfolios, with a focus on quality bonds and equity income strategies. The firm anticipates a 50-basis-point decline in U.S. policy rates by early 2026 and recommends phasing liquidity into sectors poised to benefit from lower borrowing costs and AI-driven productivity gains. Goldman Sachs, meanwhile, aligns with the broader consensus, forecasting two 25-basis-point cuts in March and June 2026, which would bring the terminal rate to 3%–3.25%. The firm emphasizes active management, particularly in small-cap equities and sectors with strong balance sheets, as a means to generate alpha in a low-volatility environment.

Tactical Considerations: Hedging and Sector Rotation

For investors, the key lies in balancing exposure to rate-sensitive assets with defensive hedges. The recent surge in SOFR options and swaptions underscores the importance of managing tail risks, particularly given the Fed's divided stance. UBS recommends using equity income strategies-such as dividend-paying stocks or equity-linked notes-to generate cash flow in a low-yield environment, while Goldman Sachs highlights the potential of active credit strategies to exploit mispricings in the bond market.

Sector rotation is another critical lever. J.P. Morgan identifies utilities, consumer staples, and healthcare as beneficiaries of lower rates, while Goldman Sachs points to small-cap equities and AI-driven tech firms as high-conviction plays. These sectors are expected to outperform as fiscal stimulus and monetary easing fuel corporate earnings growth. Additionally, the firm notes that an extended rate-cutting cycle could soften recessionary risks, further supporting risk-on sentiment.

Conclusion: Positioning for a New Policy Regime

The Fed's December rate cut marks the beginning of a structural shift in monetary policy. While the path forward remains uncertain, the consensus among major institutions is clear: risk assets are poised to outperform in a low-rate environment. Investors should prioritize equities, quality bonds, and yield curve positioning while hedging against policy volatility. As the Fed navigates its dual mandate, the ability to adapt to evolving signals will be paramount. For those who act decisively, the December meeting represents not just a policy pivot but a strategic inflection point.