How do changing interest rates affect the stock market?

Although interest rates remain elevated, they’ve stayed within a manageable range in 2025, with a limited equity market impact. Despite a generally volatile environment, stocks recovered ground lost earlier in the year. The S&P 500 fell nearly 20% from its mid-February peak, but by mid-June, it returned to positive territory year-to-date and trades at all-time highs. ¹

Throughout this period, the yield on the 10-year U.S. Treasury note remained within a broad trading range. “In that situation, 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

While interest rates most directly impact bond markets, there are spillover effects on equity markets. “Higher borrowing costs factor into 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 is often associated with muted returns.” Sandven says 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 in the 4% to 5% range, Sandven says steady rates are benefiting stocks. “ Inflation is stable for now, interest rates are range-bound and corporate earnings are trending higher,” says Sandven. “With that foundation, equities have moved higher as well.” In late June, the S&P 500 is at all-time highs, surpassing its previous high reached on February 19, 2025.

Interest rates settle in

In 2025’s early weeks, interest rates looked less stable. In January, 10-year Treasury bond yields drifted toward 5%, a level not surpassed since 2007. Bonds experienced some volatility as President Donald Trump proposed higher tariffs and the U.S. government confronted rising debt levels. But by mid-year, rates settled into a trading range mostly between 4.0% and 4.5%. ²

“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 may signal an economy slowing into a possible recession, which isn’t favorable for stocks. At 5% or higher, bond yields become much more competitive with equities, which can also detract from stock prices.”

Interest rates remaining between 4% and 5% are less likely to create equity market concerns.

Fed remains on the sidelines

Federal Reserve (Fed) interest rate policy also influences equity markets. Fed decisions to lower interest rates, especially from relatively high levels, are often viewed as a positive sign for equity markets. After cutting the federal funds target rate, a highly influential interest rate controlled by the Fed, by 1% in late 2024, the Fed has held the line so far in 2025. The fed funds target currently stands at 4.25% to 4.50%. “Investors are coming to terms with a Fed willing to stand pat for now, waiting for direction on inflation and growth,” says Hainlin.

Fed Chair Jerome Powell has indicated that the Fed is guarding against potential inflationary concerns arising from increased tariffs planned or implemented by the Trump administration. Uncertainty over the economic impact of tariffs is leading the Fed, according to Powell, to hold off on further rate cuts. ³ Markets anticipate two Fed rate cuts yet in 2025. ⁴

Sector implications

2025 sector performance is a mixed bag. In the first quarter of the year, stocks that dominated markets in the previous two years, including information technology, communication services and consumer discretionary, were all in negative territory. By contrast, energy, healthcare, consumer staples, utilities, and real estate stocks outpaced the broader market.

Second quarter performance is a different story. Technology and communication services recovered, while some of the first half’s top-performing sectors retreated. ¹

“Typically, income-oriented, defensive sectors such as utilities, energy and real estate are more dependent on favorable interest rate trends to perform well,” says Sandven. “Notably, utilities stocks performed consistently well throughout 2025’s first half.” Sandven attributes that, in large part, to positive investor sentiment for utilities companies given the rapid growth in power demand by burgeoning data center development.

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

Interest rates remain an important consideration for equity investors. “The Fed isn’t headed back to the pre-2022 ‘zero interest rate’ environment,” says Haworth. Inflation may be settling in at a higher level, in the 2.5% to 3.0% range. If that’s the case, the Fed is likely to ultimately set the federal funds target rate somewhere close to 3.0%.” The fed funds target rate currently stands at 4.25% to 4.50%. Given present interest rate trends, Haworth believes equities in general remain well positioned, driven primarily by strong economic fundamentals and solid corporate earnings growth.

As you evaluate your situation, prepare for possible fluctuations in short-term stock prices. Stocks should continue to represent a key component of any long-term investor’s diversified portfolio. “In part, this is because equity returns 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.