BofA expects December Fed cut, two more in 2026

BofA Global Research now expects the Fed to cut rates by 25 basis points at the December 9-10 meeting, reversing a prior forecast for no change, and forecasts two additional 25bp cuts in June and July 2026, bringing the terminal range to 3.00%-3.25%. The shift is attributed to weak labor market conditions and dovish signals from Fed officials (and potential leadership change), and is already reflected in market pricing—CME FedWatch shows an 87.6% chance of a December cut—while BofA warns earlier easing plus fiscal stimulus could push policy into accommodative territory.

Analysis

Market structure: A 25bp December cut tilts winners to duration and rate-sensitive assets — long-duration Treasuries, REITs (VNQ) and utilities (XLU) should outperform near-term while banks (BAC, regional peers) face NIM compression. USD likely weakens 1-2% vs major crosses on a cut, supporting gold (GLD +) and commodity-demand proxies; front-end yields should fall more than the belly, flattening the curve (2s10s compression of ~10–25bp likely).

Risk assessment: Tail risks include an inflation surprise or stronger-than-expected payrolls that force a Fed pause/delay (high-impact; low probability ~15–25%), and a fiscal stimulus shock that re-steepens yields. Immediate (days): knee-jerk rallies in bonds/equities; short-term (weeks–months): rotation into cyclicals if growth re-accelerates; long-term (quarters): sustained cuts would lift growth stocks and credit spreads but compress bank margins. Key hidden dependency is Fed leadership/newsflow (chair appointment) — a shift there can reprice cuts by ±25–75bp.

Trade implications: Direct plays — buy intermediate-duration Treasuries (IEF) and VNQ; hedge banks via options/pair trades (short BAC). Use 3–6 month option structures to express conviction: buy BAC 3-month put spreads to limit cost and buy VNQ 3–6 month call spreads to lever rate-sensitivity. Position sizing: modest (1–3% portfolio per idea) and stagger entries around FOMC and payroll prints.

Contrarian angles: Consensus prices near-certain cut (87.6%); risk is underpricing a Fed hold or delayed cut — that would spike short-end volatility and widen bank outperformance. Historical parallels: 1995–96 and 2019 saw front-loaded cuts then yield re-steepening; don’t assume linear easing. Unintended consequence: early cut amid fiscal impulse could re-accelerate inflation, forcing a quick policy U-turn — keep convex hedges.

Key Decisions for Investors

• Establish a 2.5% portfolio long position in IEF (7–10yr Treasury ETF) within 48 hours after a confirmed 25bp Dec cut; target total return +4–8% over 3–9 months if belly yields fall 20–50bp; trim if 10yr yield breaches 4.25%.
• Initiate a 2% pair trade: long VNQ (REIT ETF) and short 1.5% BAC (bank exposure) to capture relative upside from rate cuts vs NIM pressure; enter within 1 week of the cut, expect VNQ outperformance of 200–500bp vs BAC over 3 months.
• Buy a protective 3-month BAC put spread sized at 1% notional (buy 3% OTM put, sell 6% OTM) to limit cost while insuring against >5% downside from NIM surprise; roll or unwind on positive NII guidance or >3% outperformance in BAC vs XLF.
• Take a 1–1.5% long in CME (CME) equity or call spread for 6–12 months to capture structural fee resilience from increased hedging activity around Fed uncertainty; add on pullbacks >5% or sell-to-buy if implied vols drop >30% post-FOMC.