How Changing Interest Rates Shape Stock Market Performance

Interest rates are the stock market’s quiet puppeteer. You won’t see them flashing on a trading screen. But they steer everything, from company profits to investor choices. Right now, interest rates are sitting higher than they were just a few years ago, yet the stock market is pushing through. Essentially, interest rates drive up borrowing costs.

When the Fed keeps its benchmark rate between 4.25% and 4.5%, as it has in 2025, businesses feel it. Loans cost more. Corporate debt gets heavier. Smaller companies, which often borrow more and have tighter budgets, take a bigger hit.

That is less cash for growth, hiring, or new projects.

Anna / Pexels / When borrowing costs rise, company profits tend to fall. Smaller profit margins mean fewer surprises on earnings reports.

Stocks can flatten or even slide. That is why higher interest rates often go hand-in-hand with more cautious investors.

Valuations Get Trimmed by Higher Rates

Interest rates play a huge role in how stocks are priced. Investors don’t just look at what a company is earning today. They care about what it might earn tomorrow. But here is the trick: Future earnings are worth less when interest rates are high.

Higher rates raise the discount rate used in models like discounted cash flow. Basically, future cash gets a smaller price tag. According to Goldman Sachs, a 1% jump in Treasury yields can drop S&P 500 valuation multiples by around 7%. That is a big move driven by a small shift.

However, not every part of the market reacts the same way. Some sectors actually like higher interest rates. Banks, for example, can earn more from the gap between what they pay on deposits and what they charge for loans. That is good news for their bottom line.

But tech? Not so much. Growth stocks get hit harder when rates rise because their value depends more on big earnings in the future. And those future earnings lose their shine in a high-rate world. Real estate also struggles since rising rates make mortgages more expensive and financing property deals tougher.

Investors Rethink Where to Park Their Cash

Interest rates also mess with investor psychology. When bond yields rise, safe assets look a lot better. Why risk it in stocks when a government bond pays over 4%? That is the mindset shift that can pull money out of the market. If higher rates come with a strong economy, stocks can rally too.

That has been part of the story in 2025. Despite high rates, the S&P 500 has hit record highs. Investors seem to believe that growth will keep earnings strong enough to justify sticking with equities.

Jakub / Unsplash / The Federal Reserve controls the short-term interest rate, and with it, a lot of market momentum. After three cuts in late 2024, the Fed is holding steady in 2025.

The target rate is between 4.25% and 4.50%, and the central bank is watching inflation carefully before making another move. Markets are pricing in one or maybe two more cuts by year-end. But it is not guaranteed. Inflation worries, tariffs, or unexpected economic data could keep rates right where they are.

The Fed’s next steps will keep investors guessing—and moving their money accordingly. Look back and you will see the pattern. Stocks don’t always tank when interest rates rise. Between 2015 and 2018, the Fed hiked rates by more than 2%, and the S&P 500 still returned an average of 8.6% a year.

That is not bad for a “tightening cycle.” Even during rate-cut periods, markets don’t always soar instantly. But over time, lower rates usually support stronger returns. Since 1929, 12 out of 14 rate-cutting cycles led to positive returns the following year.