Rate Cycle Turns: Why Preemptive Beats Reactive in Fed Policy

A single FOMC meeting is a vol event. A cycle turn is a regime change

The FOMC Vol Crush study (the prior report in this series) showed that implied volatility around individual Fed meetings is mostly noise resolution: a predictable build and crush with little tradeable edge once transaction costs are accounted for. This report asks a different question. Forget single meetings: what happens to equities, sectors, style factors, and the yield curve in the months around the moment a multi-year hiking or cutting cycle actually turns?

The starting hypothesis, and the one this report tests, is that direction alone is a weak predictor. A rate cut is not inherently bullish or bearish: a preemptive, insurance-style cut made while the economy is still healthy (1995, 2019) behaves nothing like a reactive cut made because a recession is already underway (2001, 2007, 2024). The Fed being ahead of a slowdown versus chasing one matters more than whether the policy rate is going up or down.

Classifying 32 years of Fed policy into four regimes and 11 turns

The daily Fed funds target rate from 1994 to 2025 is built from hardcoded FOMC decision history (no FRED dependency, fully reproducible) and classified into four regimes: Hiking, Cutting, Hold (Elevated), and Hold (Zero Lower Bound). A "turn" is the first hike after a sustained hold or cutting period, or the first cut after a sustained hold or hiking period. Each regime label can recur (Hold-Elevated appears in four separate multi-year spans), and each occurrence is treated as its own contiguous spell for drawdown purposes.

Two cut types are isolated from the main first-hike/first-cut aggregates rather than blended in: insurance cuts (1995, 2019), made preemptively with no recession that followed, and the 2020 COVID emergency cut, a structural outlier on every dimension (a 9-trading-day regime spell, VIX above 75). All three are shown individually throughout this report, never averaged into the main reactive-cut statistics.

The chart below traces that policy path in full. Each cycle turn is marked on the rate line and coloured by how it is treated in the analysis (main aggregate, isolated insurance cut, or the COVID outlier), and the four regimes are shaded behind it.

The calm after the hike, not the hike itself, is where the market makes money

Across the full 1994-2025 sample, the S&P 500's best risk-adjusted regime is Hold (Elevated) (Sharpe +1.31, annualised return +19.5%), not Hiking itself. The worst is Cutting (Sharpe -0.32, annualised return -8.2%), dragged down by the 2001 dot-com unwind and the 2007-09 GFC, both of which fall inside Cutting regimes. Hiking itself is mildly positive (Sharpe +0.39): markets tend to tolerate a Fed that is removing accommodation in a healthy economy.

Reactive cuts hurt equities for 90 days. Preemptive cuts and hikes mostly don't

Each turn is re-indexed to trading days T-30 through T+90 around the announcement, with the SPX level rebased so T0 (the turn date) equals 100. Averaging across the 3 reactive first-cuts (2001, 2007, 2024), the index is at -3.2% by T+90. Averaging across the 5 first-hikes, it is roughly flat at -1.7%. The two isolated insurance cuts and the COVID emergency cut all finish higher: 1995 at +7.0%, 2019 at +5.5%, and the COVID V-shaped recovery at +6.0%.

VIX tells a consistent story. Around reactive cuts, implied vol starts already elevated (21.7 at T0) and remains elevated through T+90 (22.9), as the Fed is responding to a problem that is still unfolding. Around hikes, vol starts lower (19.0 at T0) and drifts down further (17.0 by T+90), consistent with a Fed acting from a position of relative calm.

Every turn, individually

With 11 total turns, hiding behind group averages would understate how much the individual cases vary. The 2022 hike, into an inflation shock, is the single worst hike outcome (T+90 -10.0%). The per-turn table below shows each episode individually.

Quality and value factors rise into reactive cuts, even as the market falls

Using the Fama-French five factors plus momentum (Mkt-RF, SMB, HML, RMW, CMA, MOM), the clearest pattern in the whole report shows up here. In the reactive-cut transition window, the market factor falls -4.1% by T+90, but Quality (RMW) rises +2.3%, Value (HML) rises +3.3%, and Conservative Investment (CMA) rises +1.8%. A flight to quality and value, funded out of the market factor, is the dominant rotation around reactive cuts. Around hikes, factor moves are smaller and less directional in either group.

By regime, full sample

Momentum's regime pattern is the standout caution here: best in Hold-Elevated (Sharpe +1.05) and worst in Hold-ZLB (Sharpe -0.34), consistent with the well-documented momentum-crash risk during the sharp market reversals that mark the start of zero-rate recovery periods.

The 2s10s curve steepens hard after reactive cuts, flattens through hikes

The 10Y-2Y spread moves in opposite directions around the two turn types. Around first hikes it flattens by -0.31 points from T0 to T+90, the textbook tightening response as short rates rise faster than long rates. Around reactive first cuts it steepens by +0.70 points, as the Fed cuts the front end faster than long yields fall, the classic post-recession-onset steepening.

Curve and vol levels by regime

What this is, what it isn't, and what to take away

Conclusions