The first half of 2026 saw the market shift from anticipation of rate cuts to a “higher-for-longer” stance, while navigating changes in Federal Reserve leadership and communication style.
Still, what the market may not be fully discounting is the possibility of an outright rate hike. The CME FedWatch tool sees just over a 20% chance of a July meeting hike, but expectations for subsequent meetings remain meaningful.
Federal Reserve Bank of Cleveland President Beth Hammack has made clear that a hike remains firmly on the table.
“We’ve got inflation that’s too high, and it’s been too high for the past five years,” Hammack said in a CNBC interview. “I keep an open mind walking into every meeting. I think every meeting is a live meeting.”
Her comment fits squarely within the new approach under Chair Kevin Warsh. Instead of telegraphing future moves, Warsh has argued markets should react to incoming economic data rather than Fed signaling.
For passive ETF investors, history suggests the biggest casualties of another tightening cycle may not be where conventional wisdom expects.
Surprising Winners and Unlikely Laggards
A 25-year Wall Street Journal analysis of S&P 500 sector ETFs found technology and energy—not defensive sectors—have historically delivered the strongest returns during periods of rising interest rates.
Technology averaged monthly gains of 1.24%, while energy led all sectors at 1.31%. Consumer staples and healthcare were the weakest performers, returning just 0.38% and 0.42%, respectively.
The situation creates a particularly difficult setup for traditional “bond proxy” ETFs. Utilities ETFs such as State Street Utilities Select Sector (NYSE:XLU) and real estate funds, including State Street Real Estate (NYSE:XLRE) and Vanguard Real Estate Index Fund (NYSE:VNQ), face a double squeeze.
Higher borrowing costs pressure capital-intensive businesses, while rising Treasury yields make their dividend payouts relatively less attractive. Charles Schwab‘s latest research ranks Real Estate as “Least Favored” and Utilities as “Less Favored” due to elevated valuations and financing risks.
Consumer staples might also disappoint risk-averse investors. Although the sector carries a defensive reputation, Schwab sees the companies facing sluggish revenue growth and persistent margin pressure from input-cost inflation. The opinion aligns with WSJ’s historical analysis, which points to staples consistently lagging during hiking cycles.
Consumer discretionary shares face another challenge. Schwab rates the sector “Least Favored,” citing deteriorating free cash flow, weakening consumer confidence and heightened sensitivity to restrictive monetary policy—all factors that could weigh on ETFs such as State Street Consumer Disc (NYSE:XLY) if rates climb again.
The winners could look surprisingly familiar.
Technology ETFs like State Street Technology Select (NYSE:XLK) have historically outperformed despite higher rates, challenging the long-held assumption that expensive financing inevitably hurts growth stocks.
“The sector’s fundamental growth is being supported by factors including cloud computing, AI, digital transformation, the shift to electric vehicles and self-driving technology, and demand for labor-saving and automation solutions like robots,” the firm wrote. Although due to strong concentration risk – the top 3 stocks make up nearly 60% of the group- it rates it Neutral.
Industrials and materials could also prove resilient. Schwab classified both as “More Favored,” citing sustained spending on automation, reshoring, and data-center construction that is less reliant on short-term borrowing costs.
Energy remains the historical standout. With commodity inflation and geopolitical risk premiums, the sector has consistently generated the strongest returns during previous hiking cycles.
Thus, betting on the next Fed hike might help ETFs like Energy Select Sector SPDR Fund (NYSE:XLE) more than traditional defensive sectors investors might instinctively reach for.
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