Interest rates continue to play a significant role in shaping the performance of both bond and equity markets, according to research from U.S. Bank Asset Management Group and Bloomberg. While interest rates most directly affect bonds, their impact extends into the stock market.
Terry Sandven, chief equity strategist with U.S. Bank Asset Management Group, said, “Higher borrowing costs affect business and consumer spending which can impact corporate profitability. For equity investors, lower profitability often leads to muted returns.” Sandven also noted that equities tend to perform better when interest rates are low.
In early 2025, 10-year Treasury bond yields approached 5%, a level not seen since 2007. This increase was influenced by President Donald Trump’s higher tariff proposals and growing U.S. government debt levels, leading to volatility in the bond market. By mid-2025, yields stabilized between 4.0% and 4.5%.
The Federal Reserve’s policy on interest rates has been another key factor for equities this year. After reducing the federal funds target rate by one percentage point at the end of 2024, the Fed has kept it steady at a range of 4.25% to 4.50%. Investors expect two additional quarter-point cuts before the end of this year and more reductions in 2026.
Bill Merz, head of capital markets research for U.S. Bank Asset Management Group, said: “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.”
Sector performance across the stock market has varied throughout the year. Early on, information technology, communication services and consumer discretionary stocks—previous leaders—fell into negative territory while energy, healthcare, consumer staples, utilities and real estate outperformed broader indexes.
However, as of late August data shows that communication services, industrials, information technology and utilities sectors have each gained at least 14% so far this year while healthcare and consumer staples have lagged behind.
Eric Haworth from U.S. Bank Asset Management Group commented on future trends: “The Fed isn’t returning to the pre-2022 ‘zero interest rate’ environment,” he said.“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 current fed funds target remains at a range between 4.25%and4 .50%. Haworth believes strong economic fundamentals combined with solid corporate earnings position equities well for continued growth.
Haworth also advised investors: “Stocks are an important contributor to long-run portfolio returns,and can help investors keep pace with inflation.”
Financial professionals recommend reviewing investment portfolios regularly in light of changing market conditions,risk tolerance,and long-term goals.
