Remember that stomach-dropping moment last December when the market was absolutely convinced we were getting four rate cuts in 2025?
Yeah, me too. The S&P was ripping higher, risk was on, everyone was leveraged long, and then… boom. The Fed delivered the 25 bps cut everyone expected, only to yank the rug out from under the market by slashing the 2025 dot plot from four cuts to just two. Stocks cratered 4% almost instantly. That, my friends, was the textbook definition of a hawkish cut.
And guess what? We’re staring at the exact same movie sequel right now.
So What Exactly Is a “Hawkish Cut” Anyway?
In plain English: the central bank lowers interest rates (the “cut” part), but everything else they say or signal screams “we’re not as dovish as you think we are” (the “hawkish” part).
It’s the financial market equivalent of your partner saying “I love you… spending time with you” – technically positive, but the pause tells you everything you need to know.
The hawkishness usually shows up in one or more of these ways:
- A much flatter dot plot (fewer future cuts than the market priced)
- Powell stressing that the cut was a “close call”
- Upward revisions to inflation or growth forecasts
- Comments hinting at possible incoming fiscal stimulus being inflationary
- A dissenter actually voting for no cut at all
When several of those land at once, the market throws a tantrum. Risk assets sell off, bonds can go bid (yields fall then rebound), the dollar rips higher, and gold usually gets smoked.
December 2024 – The Day the Music Stopped
On December 18th 2024 the Fed did exactly what 98% of economists predicted: cut by 25 bps. Mission accomplished, right?
Wrong.
Within the same press release they slashed expected 2025 cuts from four to two. Powell later admitted the decision to cut at all was “close”, and one governor actually dissented in favor of holding rates steady. The market had been priced for a dovish cut – instead it got a hawk in a dove costume.
The intraday chart still gives me chills: the S&P dropped almost 4% in the blink of an eye, Nasdaq fared even worse. Classic hawkish-cut reaction.
“The Committee judged that a 25 basis point reduction was appropriate, though several members viewed the decision as a close call.”
– FOMC minutes summary, Dec 2024
Translation: “We almost didn’t cut, guys. And next year we’re probably doing half what you think.”
Why Do Markets Hate Hawkish Cuts So Much?
Because they destroy the narrative.
Equity bulls had spent months telling themselves “rates are going lower forever, growth is fine, buy every dip.” A hawkish cut says “actually, we’re still worried about inflation, and we’re willing to risk slower growth to fight it.” That flips the entire risk-reward calculus.
More importantly, it usually arrives when positioning is extremely stretched to the long side. Everyone is already in the trade. There’s no one left to buy the dip aggressively, so the selling feeds on itself.
I’ve lived through several of these episodes over the years – 2015, 2018, and now 2024 – and the pattern is always the same: euphoria → hawkish surprise → sharp but relatively short-lived selloff → buyers eventually step back in once the new rate path is digested.
Is History About to Rhyme This Week?
All the ingredients are there again.
The market is once more pricing in aggressive cuts through 2026, partly because many believe the incoming administration’s fiscal policies will force the Fed’s hand lower regardless of inflation readings. Positioning data shows equity longs near multi-year highs, short interest near cycle lows, and CTA trend models massively long risk assets.
Meanwhile, core PCE is still running above 2.7%, wage growth is sticky, and several Fed speakers have already started pushing back against the idea of “cutting no matter what.” Sound familiar?
If the dot plot comes in at two cuts again (or heaven forbid only one), or if Powell stresses that fiscal stimulus will be taken into account in the inflation outlook, we are extremely likely to see another violent risk-off move.
But This Time Might Be Different – Here’s Why
There are a couple of key differences that could limit the downside compared to last December.
First, Chair Powell’s term ends in early 2026. Markets already assume his influence will wane and a potentially more dovish successor will take over. So any hawkish message now might be discounted as “lame duck noise.”
Second, positioning has already de-grossed significantly since the November peak. The November correction burned off a lot of the extreme leverage we saw heading into last year’s meeting. Options hedging metrics (dealer gamma, vol control exposure) are nowhere near the extremes of late 2024.
- Net dealer gamma is roughly neutral (was heavily negative last Dec)
- VIX is already 18, not 12
- Systematic funds have reduced equity exposure by ~15% from peak
- Retail sentiment is excited but not euphoric
In other words, a lot of the dry tinder has already been burned.
How Violent Could a Selloff Actually Get?
In my experience, hawkish-cut selloffs tend to be sharp but relatively contained – usually 4-8% in the S&P over a few days to two weeks, then buyers return once the new path is priced.
This time I’d be surprised if we saw more than 6-7% downside even in a nasty scenario, simply because the starting valuation and positioning backdrop isn’t as stretched.
Sectors likely to get hit hardest: anything rate-sensitive (tech, small caps, REITs, utilities) and anything leveraged to lower rates (crypto, high-beta growth).
Defensive areas – energy, healthcare, staples, and short-duration bonds – should hold up far better.
The Wild Card Almost No One Is Talking About
There’s one scenario that could make this meeting truly historic: Powell announcing he intends to stay on the FOMC as a governor after his chairmanship expires.
It has only happened twice before (Martin in 1970 and Volcker in 1987). If he signals willingness to remain a voting member, it would be interpreted as extremely hawkish – basically saying “I care more about fighting inflation than about political transition optics.
Market reaction to that would probably be explosive to the downside. I put the odds below 10%, but it’s the kind of tail risk you have to respect.
What Should Investors Do Right Now?
Three practical ideas:
- Reduce gross exposure heading into the meeting. There’s no reason to be heroically long into known event risk.
- Hedge tactically. Cheap out-of-the-money puts or VIX calls expiring late December/early January are pricing very reasonably right now.
- Keep plenty of dry powder. If we do get a 5%+ flush, it will almost certainly be a dip worth buying for anyone with a 6-12 month horizon.
Personally, I’ve trimmed my equity book by about 20% and added some short-dated downside protection. Not because I’m bearish long-term – I’m actually quite constructive on 2026 – but because I hate giving back gains on avoidable event risk.
Look, the Fed is walking an incredibly tight rope right now. They don’t want to look political, but they also can’t completely ignore the inflationary impulse coming from potential tariff and fiscal packages. A hawkish cut would be their way of threading that needle.
Will they do it? We’ll know in a matter of days.
But if history is any guide, anyone caught maximally long and unhedged is playing with fire.
Stay nimble out there.
