How do changing interest rates affect the stock market?

Interest rates sit at the center of today’s investment conversation because they shape stock valuations and the financing conditions that help companies grow. When rates rise, they lift borrowing costs for the government, consumers and businesses, and that pressure can squeeze profit margins and slow earnings momentum. When rates fall or stabilize, financing becomes easier, confidence often improves, and equities find firmer footing – especially when the economic backdrop stays constructive.

Investors keep a close eye on the Federal Reserve (Fed) because Fed policy sets short-term rates and indirectly influences longer-term yields across the economy. As the Fed adjusts its target Federal Funds rate, those changes can flow quickly into consumer finance rates, corporate funding costs, and overall financial conditions, reshaping growth and profit expectations. Even with rates elevated versus the past decade, the market recently benefited as yields moved lower alongside multiple Fed interest rate cuts, while the 10-year U.S. Treasury note yield largely traded in a 4.0%-4.25% range that gives investors a clearer benchmark for discount rates and relative value decisions. ¹

“Despite still elevated interest rates, solid corporate earnings growth supports equity prices,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management Group. The S&P 500 also recently reached new all-time highs, rebounding from last year’s volatility when stocks dropped nearly 20%. ² Together, those moves reinforce a practical point for investors: rates set the backdrop, but earnings and expectations often decide how stocks respond day to day.

How interest rates filter into stock prices

When rates remain steady or drift lower, companies can refinance, invest and plan with more confidence, and that often supports stock prices. Consumers can also feel the difference, particularly for interest-sensitive purchases, which can help keep demand healthier than it might be in a rising-rate environment. At the same time, lower financing costs can reduce the drag that interest expense creates on business expansion and profitability.

Rates also influence what investors are willing to pay for future earnings because yields affect the “discount rate” used to value long-term cash flows. As financial conditions ease, investors often regain comfort paying higher prices for durable earnings, particularly when growth remains constructive. Terry Sandven, chief equity strategist with U.S. Bank Asset Management Group, summarizes the dynamic this way: “Relatively stable inflation, rangebound to lower interest rates and rising corporate earnings support stock prices,” says Sandven.

Fed cuts and what the yield curve tells us

The Fed has actively reduced the fed funds target rate, cutting it by 1% in late 2024 and by 0.75% total over the three meetings to conclude 2025. Those actions 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, while investors expect two to three additional cuts—an important reminder that market pricing can diverge from officials’ guidance.

Longer-term yields tell a related story about inflation expectations and risk appetite, and they can move for multiple reasons at once. Last January, 10-year Treasury bond yields reached 4.8% but have not exceeded 5.0% since 2007, which remains a meaningful reference point for investors who remember earlier, higher-rate regimes. ¹ The push-and-pull matters because stocks often react differently depending on why yields move, not just whether they move.

If yields fall because inflation cools while growth holds up, equities may respond favorably as investors gain confidence in a “soft landing” narrative. If yields rise because inflation pressures reaccelerate or fiscal concerns dominate, markets may demand a larger risk premium and become more selective about which stocks can sustain higher valuations. That’s why the same direction in yields can lead to very different market outcomes depending on what drives the change.

Policy tailwinds and the earnings backdrop

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.

At the same time, bond market volatility has remained part of the landscape as the market weighs inflation, growth and fiscal dynamics together. President Donald Trump’s higher tariffs and the U.S. government’s rising debt levels contributed to volatility, yet rates fell as inflation expectations eased and the Fed cut interest rates. ¹ This mix underscores a key reality for investors: multiple forces can push yields in different directions, and equities will often follow the earnings outlook more than any single headline.

Stock market sector implications: Rates matter, but catalysts matter more

Sector leadership has shifted as investors reassessed growth expectations, earnings durability and interest-rate sensitivity. Early last year, the groups that dominated the prior two years— information technology, communication services and consumer discretionary –fell into negative territory while energy, healthcare, consumer staples, utilities, and real estate outpaced the broader market. Over the past year, however, communication services, information technology, industrial and energy sectors performed best, each exceeding the S&P 500’s 16.9% total return for the one-year period ending in late January 2026. Meanwhile, traditionally defensive categories like real estate and consumer staples lagged. ³

Interest 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.”

Utilities also illustrate why investors often need to look beyond rates to understand performance. A powerful non-rate catalyst—growing data center development and the associated electricity demand surge—reinforced utility strength. Sandven attributes solid utility performance largely to that burgeoning data center development, which drives rapid power demand growth and supports investor sentiment for utilities serving those power needs.

Stock market’s path forward in today’s interest rate environment

Interest rates remain a crucial factor for equity investors, but markets rarely move on rates alone, and the Fed has signaled it won’t rewind the clock to the prior decade’s extremes. “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. The most effective decisions tend to come from a plan you can stick with across cycles rather than a reaction to any single rate move.

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.

FAQs

How do interest rates affect the stock market?

Interest rates directly influence investor decisions in the stock market. When rates rise, investors often shift their money into bonds because these now offer more attractive yields than before. As a result, companies must work harder to deliver stronger earnings to keep investors interested, and higher borrowing costs can reduce profits, which may lead to lower stock prices.

Do interest rate hikes hurt the stock market?

When the Federal Reserve raises the short-term federal funds target rate (as it did in 2022 and 2023), stocks often face immediate challenges. A higher interest rate environment tends to slow business activity and can negatively impact the economy. As corporations experience lower revenues and earnings, their stock prices may decline in response.

Do interest rates go up when the stock market goes down?

Stock market movements do not directly determine the direction of interest rates. Instead, economic conditions and inflation play a much larger role in determining the direction of interest rates. When stock prices fall, investors may seek safer investments like bonds, increasing demand for bonds and allowing issuers to offer debt at lower interest rates.