Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / When the Fed Hikes Into a Soft Landing What History Says
Transcript
- Lucas: Minneapolis Fed President Neel Kashkari said Friday he expects a rate hike this year. Let's be clear — he's not the FOMC chair, but he's a voting member in 2026, and he's the first Fed official to publicly break with the 'no hikes in 2026' consensus that's been priced into fed funds futures. Luna: And markets didn't love it, right? The S&P 500 dipped, the VIX jumped nine percent in a week to 18.41. But it's not panic — yet. Lucas: Right. The VIX at 18.41 is elevated relative to the calm we had in April and May, but it's not screaming. What's more interesting is the yield curve. The 10-year is at 4.40 percent, the 2-year at 4.09 — the spread is 31 basis points, still inverted. And Kashkari's comments actually pushed the short end up more than the long end, steepening the curve slightly. Luna: So the bond market is still pricing in a recession eventually? Because an inverted curve is the classic recession signal. Lucas: It is. But here's the thing — we've been inverted since late 2022. That's over three and a half years. Historically, inversions have preceded recessions by 12 to 24 months. This is the longest inversion without a recession on record. And the Fed funds rate is at 4.50 to 4.75 percent — not extremely tight by historical standards. Luna: If our money conversations have helped you think about a decision differently, maybe you've reconsidered a trade or held through a dip you otherwise would have sold — a couple of dollars a month is genuinely what keeps these episodes ad-free. Buy me a coffee dot com slash fexingo, if you've gotten something out of them. Lucas: Yeah, that's exactly right. And it makes a real difference. So — back to Kashkari. The market's immediate reaction was predictable: sell stocks, buy short-term Treasuries. But the bigger question is whether a 2026 rate hike would actually derail the soft landing. Luna: And that's where history comes in. You mentioned 1994 earlier — that's the classic example of the Fed hiking without causing a recession. Lucas: Exactly. In 1994, the Fed under Alan Greenspan hiked rates from 3 percent to 6 percent — 300 basis points — in a year. Everyone said it would cause a recession. Instead, GDP growth slowed from about 4 percent to 2.5 percent, but never went negative. The S&P 500 actually returned about 1 percent in 1994, but then ripped 34 percent in 1995. Luna: So the market sold off during the hiking cycle, then rebounded once the Fed paused. Lucas: Yes. And the current situation has similarities. Real GDP growth just came in at 2.1 percent annualized for Q1 2026 — that's down from the 3 percent plus we saw in 2024 and early 2025. So the economy is slowing. But it's not contracting. The question is whether the Fed would be hiking into a slowdown that's already underway. Luna: Which sounds dangerous. But Kashkari's argument, as I read his comments, is that inflation is still sticky — maybe not at 3 percent, but above the 2 percent target. And with the labor market still tight, he thinks one more hike is insurance. Lucas: That's the argument. The core PCE — the Fed's preferred gauge — has been hovering around 2.6 to 2.8 percent for months. It's not dropping. And the JOLTS data, while we don't have today's release, has shown around 8 million job openings — still above pre-pandemic levels. So the Fed has a rationale. Luna: But the bond market is screaming that they've already done enough. The 10-year yield at 4.40 percent, the 30-year at 4.86 — long-term rates are telling us growth expectations are moderating. Lucas: And that's the tension. Let's look at what actually happened in prior episodes where the Fed hiked into a slowing economy. Take 1984 — the Fed hiked the discount rate from 8.5 percent to 9 percent in 1984 even as GDP growth was decelerating from 7.2 percent to 4 percent. The economy did slow further, but no recession. The S&P 500 fell about 6 percent in the second half of 1984, then rallied 28 percent in 1985. Luna: So the pattern is: a correction, then a rally once the pivot is confirmed. Lucas: Yes. But there's a crucial difference today. In 1984 and 1994, the yield curve was steep — long rates were well above short rates. Now, the curve is inverted. That inversion is a sign that the bond market expects future growth to be much weaker. And if the Fed hikes into that, the inversion deepens — which historically has been a bad omen. Luna: So the risk is that Kashkari's single hike, even if it happens, could push the economy from slowing to contracting if the bond market is right. Lucas: Exactly. And that's why the market reaction on Friday was sharp but contained. The VIX at 18.41, up 9 percent for the week — that's not panic. But if we get another Fed speaker reinforcing that message, or if the CPI or PCE data next month comes in hot, you could see the VIX spike toward 25. Luna: And if it does, what's the play? I mean, historically, buying the dip during Fed tightening cycles has been profitable — but only if you time it after the last hike. Lucas: That's the million-dollar question. If you look at the 1994 cycle, the bottom in the S&P 500 came in November 1994 — the month the Fed hiked for the last time. If you bought then, you caught the entire 1995 rally. But if you bought in February 1994 — the first hike — you had to sit through a 9 percent drawdown. Luna: So the key is identifying the last hike. And right now, no one knows if Kashkari's hike would be the last. Lucas: Right. The fed funds futures are pricing a 30 percent chance of a hike by December. That's not a lock. But it's a real tail risk. And the prudent move might be to wait for confirmation — either the hike itself or a clear pivot in the data — before adding risk. Luna: What about sectors? Are there any that tend to hold up better when the Fed hikes late cycle? Lucas: Historically, energy and health care have been defensive during late-cycle hikes. Energy benefits from the inflation that's prompting the hike, and health care is demand-inelastic. Technology tends to get hit hardest because of the duration sensitivity — high-growth stocks have cash flows far in the future, which get discounted more when rates rise. Luna: The Nasdaq is at 25,298 — up about 8 percent year to date. But if rates go up, that multiple compression could really hit. Lucas: Absolutely. The Nasdaq's forward P/E is around 28. A 25 basis point hike — if it happens — might shave 1 to 2 turns off that multiple. That's a 5 to 10 percent downside from multiple compression alone, before you factor in any earnings revisions. Luna: So for the average listener, what's the actionable takeaway? Hold cash? Rotate into defensives? Lucas: I think the most honest answer is: don't try to front-run the Fed. If you're long-term, staying invested is fine — the S&P 500 at 7,354 is up about 12 percent from a year ago. But if you're tactical, I'd consider trimming positions in high-duration, high-beta stocks and adding to energy, health care, and maybe short-duration bonds. The 2-year Treasury at 4.09 percent is a decent risk-free return while you wait for clarity. Luna: And if the hike doesn't come? If inflation cools and the Fed stands pat? Lucas: Then you miss a potential rally in tech and growth. That's the risk of being cautious. But given the uncertainty — the yield curve inversion, the slowing GDP, the Kashkari comments — I'd rather miss the first leg of a rally than get caught in a late-cycle tightening that turns into a recession. Luna: Fair. And that's the balance. The market is pricing a soft landing, but history shows that soft landings are rare. The Fed has only pulled off a true soft landing a few times — 1994-1995 being the best example. Lucas: Right. And even in 1995, the economy did slow. GDP growth dropped from 4 percent to under 2 percent before rebounding. So a soft landing doesn't mean no pain — it means no recession. And the bond market is still saying recession. That's the fundamental disagreement underlying every single move this quarter. Luna: We'll be watching the June CPI release on July 15. If that comes in hot, look for the VIX to spike and the odds of a hike to jump. If it's cool, Kashkari might be a lone voice. Lucas: Exactly. And that's what makes this moment interesting. One Fed official, one data point, can shift the narrative. For now, the base case is no hike. But the tail risk is real. And in a market at all-time highs, tail risks are worth respecting.