# Relationship between Fed Rates, Recession and Bond Yields

This is the **core of modern rate-cycle psychology** — and one of the most important mental models in macro trading.

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## Why Do Markets Think the Fed Will Cut After Hiking?

Let’s walk through it step by step like you're running a macro fund:

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### 1. **Fed Hikes to Control Inflation**
- When inflation is too high, the Fed raises the **Fed Funds Rate**.
- This makes borrowing **more expensive**:
- Mortgage rates go up.
- Credit card debt costs more.
- Companies delay hiring and investment.

📉 Demand slows → inflation cools.

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### 2. **But High Rates Also Slow the Economy**
- Higher rates choke off:
- Consumer spending
- Corporate borrowing
- Business expansion
- Eventually this hits:
- Jobs
- GDP
- Risk assets

So while inflation may fall... **growth might stall** or even contract → **recession risk.**

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### 🔄 3. **Recession = Fed Will Need to Cut**
Markets price in that:
- The Fed will need to **pivot**.
- They'll start **cutting rates** to stimulate growth and avoid deep recession.
- Especially if:
- Unemployment starts rising
- Credit markets freeze up
- Corporate earnings tank

This is why:

> When Fed is **hiking aggressively**, the market thinks:
> “Okay, they’ll go too far → break something → then reverse course.”

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### 🔁 4. **Bond Market Front-Runs This**
- Long-term bond yields drop in anticipation of future rate cuts.
- That’s why the **yield curve inverts**:
- **2Y = high** (short-term policy rate)
- **10Y = lower** (expecting recession and future cuts)

This is the market’s way of saying:
> “You're tight now, but not for long.”

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### 🧾 TL;DR:

| Fed Action | Market Thinking |
|----------------|-----------------------------------------------|
| Hiking | “They’ll kill inflation... and maybe growth” |
| High for Long | “Something’s gonna break” |
| Recession Risk | “Cuts are coming” → Buy long-duration bonds |

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Want a real example? In **2006**, the Fed hiked to 5.25%. In **2007**, the recession signs showed up. By **2008**, they were cutting to 0%.