How do changing interest rates affect the stock market?

Interest rates sit at the center of today’s investment conversation because they actively shape bond markets and stock valuations. When rates rise they lift borrowing costs for the government, consumers and businesses, which can pressure corporate profit margins and slow earnings momentum. When rates fall or stabilize, financing becomes easier, confidence tends to improve, and equities find firmer footing – especially when the economic backdrop stays constructive.

Investors watch the Federal Reserve (Fed) closely because Fed policy sets short-term rates and indirectly shapes longer-term yields throughout the economy. As the Fed adjusts its target Federal Funds rate, the change can flow quickly into mortgage rates, corporate funding costs, and overall financial conditions. Those shifts, in turn, can alter growth and profit expectations and investors’ willingness to pay higher prices for future earnings.

Even with rates elevated versus the past decade, the market recently navigated a more supportive trend as yields moved lower in recent weeks alongside multiple Fed interest rate cuts. The 10-year U.S. Treasury note yield has largely traded in a 4.0%-4.25% range, offering investors a clearer benchmark for discount rates and relative value decisions. ¹ “Despite high interest rates, solid corporate earnings growth supports equity prices,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group.

How interest rates influence equity markets

When rates remain steady or drift lower, stocks often benefit because companies can refinance, invest, and plan with more confidence. This environment can also support consumer activity, particularly for interest-sensitive purchases while helping reduce the drag from financing costs on business expansion. Terry Sandven, chief equity strategist with U.S. Bank Asset Management Group, captures the dynamic well: “Relatively stable inflation, rangebound to lower interest rates and rising corporate earnings support stock prices,” says Sandven. In December, the S&P 500 hit new all-time highs rebounding from early-year volatility when stocks dropped nearly 20%. ²

Stocks have also drawn support from policy-driven tailwinds that improve the earnings outlook and reinforce a constructive narrative for risk assets. Fiscal stimulus from the recent “One Big Beautiful Bill Act” provides stocks an extra boost by improving the corporate earnings outlook through increased deductions and lower corporate taxes, while many individuals may see lower taxes in 2026. Combined with lower borrowing costs as the Fed reduces interest rates, these forces can help corporate profits stay resilient even as investors remain alert to periodic volatility.

Federal Reserve cuts interest rates

The Fed has actively reduced the federal funds target rate, cutting it by 1% in late 2024 and by 0.75% total over the three meetings to conclude 2025. Those action brought the fed funds target to a 3.50% to 3.75% range, reshaping expectations for where financing conditions may settle next. Median Fed member projections anticipate another 2026 cut, although investors expect two to three additional cuts, highlighting how market pricing can diverge from officials’ guidance.

Interest rates settle in

Longer-term yields have also told an important story about the market’s inflation expectations and risk appetite. In January, 10-year Treasury bond yields reached 4.8% but have not exceeded 5.0% since 2007 – an important reference point for investors who remember earlier, higher-rate regimes. President Donald Trump’s higher tariffs and the U.S. government’s rising debt levels contributed to bond market volatility, yet rates fell as inflation expectations eased and the Fed cut interest rates. ¹

This push-and-pull underscores a key reality for investors: rates can move for multiple reasons at once, and stocks may react differently depending on what drives the move. If yields fall because inflation cools while growth holds up, equities may respond favorably. If yields rise because inflation pressures reaccelerate or fiscal concerns dominate, markets may demand a larger risk premium and become more selective.

Sector implications

Sector leadership has shifted this year. Early in the year, stocks that dominated markets in the previous two years, including information technology, communication services and consumer discretionary, all fell into negative territory while energy, healthcare, consumer staples, utilities, and real estate outpaced the broader market. Over the full year, however, communication services, information technology and industrial sectors have performed best, each exceeding the S&P 500 gain of more than 17.7% so far in 2025. Meanwhile, traditionally defensive categories like real estate and consumer staples have lagged. ³

Rate sensitivity still matters at the sector level, but the market has rewarded fundamentals and specific demand drivers as much as rate exposure. “Typically, falling interest rates help income-oriented, defensive sectors such as utilities, energy and real estate perform well,” says Sandven. “Notably, utility stocks outperformed other interest rate sensitive sectors.”

In utilities, a powerful non-rate catalyst has reinforced performance: growing data center development and the associated electricity demand surge. Sandven attributes solid utility performance largely to burgeoning data center development, which drives rapid power demand growth and fosters positive investor sentiment for utilities companies serving those power needs. This theme highlights a helpful investing principle in today’s environment: rates set the backdrop, but earnings drivers often decide the winners.

The stock market’s path forward in today’s interest rate environment

Interest rates remain a crucial factor for equity investors, but the market rarely moves on rates alone. “The Fed doesn’t plan on returning to the pre-2022 ‘zero interest rate’ environment,” says Haworth. “Inflation may stabilize somewhat above their 2.0% target, which could lead the Fed to ultimately set the federal funds target rate close to 3.0% compared to the current rate of 3.50% to 3.75%.”

That outlook argues for a balanced, forward-looking approach: expect short-term swings while staying anchored to long-term fundamentals. Given present interest rate trends, Haworth believes solid economic fundamentals and strong corporate earnings keep equities well positioned for growth. As you review your portfolio, prepare for possible short-term stock price fluctuations and remember that, “Stocks are an important contributor to long-run portfolio returns, and can help investors keep pace with inflation,” says Haworth.

Talk with your wealth professional about your comfort level with your portfolio’s current investment mix. Discuss whether any changes are appropriate in response to evolving capital market conditions, consistent with your goals, risk appetite and time horizon.

Note: The Standard & Poor’s 500 Index (S&P 500) consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The S&P 500 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results. Past performance is no guarantee of future results.