Jeff Schulze, Head Investment Strategist at the Franklin Templeton Institute, makes the case that today's tightening cycle is unlike the ones that ended in recessions.
The Dashboard Still Says Green
With eleven of twelve indicators flashing expansion and recession odds sitting at a modest 15%, Jeff Schulze opens the October edition of Talking Markets1 from a position of measured confidence. "Out of those 12 individual indicators, 11 are green," he states. "None of them are yellow, and only one is red. So when you have a dashboard output of this nature, typically recession odds are a modest 15% over the next 12 months."
That is the framing for everything that follows. The Recession Risk Dashboard, Schulze's primary diagnostic tool at the Franklin Templeton Institute, is not flashing distress. The economy, he argues, is on a solid foundation, even as markets contend with a meaningful rise in bond yields, a softening labor market, and a Fed that has pivoted from rate cuts to rate hikes.
A Labor Market That Is Simmering, Not Boiling
September's jobs report came in well below expectations: 29,000 versus a consensus of 90,000, with negative revisions to July and August totalling 60,000. Wage growth was barely positive on a month-over-month basis, and the unemployment rate ticked higher. Schulze does not dismiss the softness, but he contextualizes it clearly. "The labor market is not boiling," he says. "It's simmering."
He attributes the slowdown to structural shifts: reduced immigration flows and an accelerating wave of early retirements by baby boomers sitting on record-high capital markets gains. One notable positive, he points out, is the recovery in the prime-age labor force participation rate, which jumped 0.3% in the latest release after a 0.6% plunge in July. On balance, Schulze expects job prints in the zero to 100,000 range through the rest of 2026 and into early 2027, framing this as a new equilibrium rather than a deterioration.
A High Bar for October
Fed fund futures moved sharply after the September jobs report, dropping from a 70% probability of an October hike to just 22%. Schulze thinks that repricing feels about right. With multiple FOMC members signalling patience, he sees December as the more likely window for the next move and believes that may be the last hike of the cycle. The soft wage growth data, he argues, removes any urgency. "That really allows the Fed to remain flexible and take a more patient approach to the next rate hike."
The Critical Distinction: Modest Versus Aggressive
The core analytical argument of the piece is structural. "Bull markets don't die of old age," Schulze says. "They're killed by the Fed." But the mechanism matters. Looking back at every hiking cycle since 1980, the cumulative size of the tightening is what determines the economic and market damage. The 2004 to 2006 cycle delivered 425 basis points of hikes. The 2022 to 2023 cycle delivered 525 basis points at the fastest pace in forty years. Both produced equity bear markets; one ended in recession.
Today, Fed fund futures are pricing approximately 115 basis points of cumulative hikes. "If that's accurate," Schulze notes, "it's going to be the most modest hiking cycle in history." That distinction has direct implications for asset allocation. In modest hiking cycles, EAFE equities have returned 13.2% on average in the year following the first hike. Emerging market equities have returned 8.7%. Emerging market bonds have returned a notably strong 15.2%.
Real Yields Are Doing the Heavy Lifting
The 10-year Treasury yield has risen approximately 130 basis points since its February low. Schulze is precise about the attribution. Of that 130 basis points, roughly 90 basis points reflects an increase in real yields, 20 basis points reflects higher inflation expectations, and 26 basis points reflects a wider term premium. Fiscal sustainability fears and debt monetization concerns, he argues, simply do not fit the data. Long-term credit default swaps on U.S. Treasury debt are nearly unchanged. The term premium, at around 70 basis points, remains modest by historical standards.
The rise in yields, he contends, is better understood as a normalization from the distorted post-GFC environment of near-zero rates, deflation risk, and unconventional monetary policy. Nominal GDP is running at approximately 6%. A 10-year Treasury at 5.3% is not a crisis. It is a return to the relationship between bond yields and economic growth that prevailed before the 2010s.
The Equity Market Is Telling Its Own Story
Perhaps the most striking observation Schulze offers is the resilience of equities through all of this. "If you would have asked me six months ago, where would equity markets be if you had a barrel of oil go up close to $40, you had the 10-year Treasury rise by 130 basis points, the Fed went from expected to cut two and a half times to being hiking four times, and the market was near an all-time high, I would have said you were crazy."
The equity market, in his reading, is pricing in stronger GDP growth, strong earnings, and the early stages of a productivity wave driven by AI investment. "We're probably on the cusp of a productivity wave from all this AI investment," he says. Add to that the historically reliable tailwind of the midterm election cycle, where the S&P 500 has posted positive returns in all nineteen observations since 1950 with an average gain of 15.1%, and the setup for long-term investors appears constructive.
The danger zone, Schulze is clear, is late in the cycle when real rates are deep in restrictive territory, the curve is inverted, spreads are widening, and leading indicators are deteriorating. "And right now," he says, "none of these classic signs are evident."
5 Key Takeaways for Advisors and Investors
- Recession risk remains low. With eleven of twelve indicators green on the Recession Risk Dashboard, a 15% recession probability over the next twelve months reflects a still-resilient economic foundation, not complacency.
- The Fed's tightening cycle is historically modest. At approximately 115 basis points of projected cumulative hikes, this cycle is tracking as the least aggressive in modern history, limiting the risk of the policy error that typically ends expansions and bull markets.
- Non-U.S. equities and emerging market bonds have historically outperformed in modest hiking cycles. Advisors looking beyond domestic equity exposure may find tactical opportunity in EAFE and EM allocations, where historical return data following shallow hiking cycles is notably strong.
- Higher bond yields reflect stronger growth, not a credibility crisis. The rise in the 10-year Treasury is primarily driven by real yields and nominal GDP growth, not fiscal panic or inflation expectations. Framing this as normalization rather than instability is important for client communication.
- Earnings quality, not just the peak, is what matters. Investors should focus on the level of earnings growth that follows a peak, not the peak itself. With consensus projections for forward earnings growth well above 10%, the historical relationship with forward equity returns remains supportive.
Footnote:
1 Schulze, Jeffrey, CFA. "AOR Update (Podcast): Not All Hiking Cycles Are Created Equal." Franklin Templeton Canada, 14 Oct. 2026, www.franklintempleton.ca/en-ca/articles/2026/clearbridge-investments/aor-update-podcast-not-all-hiking-cycles-are-created-equal.
