How do changing interest rates affect the stock market?

Although interest rates remain elevated, compared to the past decade, they remain rangebound in 2025 with  limited equity market impact. The S&P 500 recently hit new all-time highs recovering from early in the year volatility when stocks fell nearly 20%. ¹

Sources: U.S. Bank Asset Management Group Research, Bloomberg. Updated through August 27, 2025.

Throughout this period, the yield on the 10-year U.S. Treasury note remained within a broad trading range. “Even though interest rates may be relatively high, capital markets aren’t concerned,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group.

How interest rates influence equity markets

Interest rates most directly impact bond markets, but their influence spills over into equity markets. “Higher borrowing costs affect business and consumer spending which can impact corporate profitability,” says Terry Sandven, chief equity strategist with U.S. Bank Asset Management Group. “For equity investors, lower profitability often leads to muted returns.” Sandven notes that equities tend to perform better in a low-interest rate environment.

In today’s market, with the 10-year U.S. Treasury yield remaining within a 4% to 5% range, Sandven says steady rates are benefiting stocks. “Inflation is stable for now, interest rates are rangebound and corporate earnings are trending higher,” says Sandven. “With that foundation, equities have moved higher as well.” By late August, the S&P 500 reached all-time highs, hitting multiple new records over the summer after surpassing its previous high on February 19, 2025. ¹

Interest rates settle in

Interest rates appeared less stable in 2025’s early weeks. In January 10-year Treasury bond yields approached 5%, a level not surpassed since 2007. President Donald Trump’s higher tariff proposals and the U.S. government’s rising debt levels contributed to bond market volatility. However, by mid-year, rates settled into a trading range mostly between 4.0% and 4.5%. ¹

Sources: U.S. Bank Asset Management Group Research, U.S. Department of the Treasury. As of August 27, 2025.

“From an equity market perspective, the 10-year Treasury yield is a signaling mechanism,” says Tom Hainlin, national investment strategist with U.S. Bank Asset Management Group. “If rates dipped below 4%, it suggests shifting expectations, which could be constructive if stemming from anticipated rate cuts amid rising growth expectations – the current theme,” he notes. “However, it could also signal an economy slowing into a possible recession if economic data were to concurrently deteriorate, which isn’t favorable for stocks.” According to Hainlin, at 5% or higher, bond yields become more competitive with equities and borrowing costs become more restrictive, which can also detract from stock prices.

Fed remains on the sidelines, but rate cuts likely coming soon

Federal Reserve (Fed) interest rate policy strongly influences equity markets. When the Fed lowers interest rates, especially from relatively high levels, it often signals a positive outlook for equity markets. After reducing the federal funds target rate by 1% in late 2024, the Fed has maintained this rate so far in 2025. The fed funds target currently stands at 4.25% to 4.50%.

“Investors anticipate two 0.25% rate cuts in the final months of 2025 along with multiple additional cuts in 2026. Rate cut expectations have supported stocks and pulled bond yields near the lower end of their recent range,” says Bill Merz, head of capital markets research for U.S. Bank Asset Management Group.

Sector implications

Sector performance is a mixed bag this year. Earlier 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. In contrast, energy, healthcare, consumer staples, utilities, and real estate stocks outpaced the broader market.

However, year-to-date total returns paint a slightly different picture. Communication, industrial, information technology and utility sectors are performing best, each posting 14% or higher gains so far in 2025. Meanwhile, traditionally defensive categories like healthcare and consumer staples have lagged. ²

Sources: U.S. Bank Asset Management Group Research, Bloomberg. As of August 27, 2025.

“Typically, favorable interest rate trends help income-oriented, defensive sectors such as utilities, energy and real estate perform well,” says Sandven. “Notably, utilities stocks performed consistently well so far in 2025.” Sandven attributes this strong performance largely to burgeoning data center development driving rapid power demand growth and positive investor sentiment accruing to utilities companies serving those power needs.

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

Interest rates play a crucial role for equity investors. “The Fed isn’t returning to the pre-2022 ‘zero interest rate’ environment,” says Haworth. “Inflation may stabilize at a higher level, around 2.5% to 3.0%. If that happens, the Fed may ultimately set the federal funds target rate close to 3.0%.” The fed funds target rate currently stands at 4.25% to 4.50%. Given present interest rate trends, Haworth believes strong economic fundamentals and solid corporate earnings keep equities well positioned for growth.

As you evaluate your situation, prepare for possible short-term stock price fluctuations. Stocks should continue to be a key component of any long-term investor’s diversified portfolio. “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 mix of investments and discuss whether any changes are appropriate in response to an evolving capital market environment 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. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The Russell 2000 is an unmanaged index of stocks. It is not possible to invest directly in the index. Past performance is no guarantee of future results.