Interest Rates and Stock Prices: An Old Debate Flares up!

    The war in Iran, oil prices and worries about a recession have all taken turns driving stock prices  in 2026 but talk about interest rates and where they are going has been a constant concern all year. In the last few weeks, interest rate worries have come to the surface again, for three reasons, all related. The first is the rise in long-term US treasury rates to levels not seen in twenty years. The second is US debt exceeding $40 trillion for the first time, bringing attention to a long-standing worry that this debt burden may be hitting a tipping point for bond buyers. The third is a that the Federal Reserve has a new chair in Kevin Warsh, and for the many Fed Watchers, who are uncertain about where he plans to lead the Fed, the Federal Open Market Committee (FOMC) meeting coming up in mid-September looms larger than ever. 

    In this post, I hope to step back from the day-to-day coverage of US treasury yields and look at their performance in 2026, not only with a longer term perspective, but also in the context of movements in long terms yields in government bonds in other currencies. I also intend to revisit a discussion that I initiated in 2022, when interest rates were the central act in markets, about the relationship between interest rates and stock prices, and why higher rates do not always translate into lower stock prices, and why that effect will vary across sectors and companies.

Government Borrowing Rates

    Governments borrow money and often do so by issuing bonds in financial markets. The rates on these bonds reflect the concerns that lenders have about the purchasing power of the currencies that they are issued in, and government bond rates, for better or worse, become indicators that drive day-to-day market movements in almost all asset classes. In this section, I will begin with an examination of US treasury rates before expanding the discussion to government bond rates in other currencies.

The 2026 Interest Rate Experience

    Coming into 2026, US treasury rates had mostly moved sideways for a couple of years, but during the course of 2026, rates have risen steadily across the maturity spectrum with long term treasury rates showing more movement than rates at the short end. Both the 20-year and 30-year treasuries rose above 5% during the course of the year, and the 10-year rate, which started the year at 4.18% reached 4.75% at the end of August. The graph below looks at US treasury rates across maturities in 2026:

I know that there are some who attribute almost everything related to interest rates to the Fed, and while I think that is simplistic and wrong-headed to do so, I show the four FOMC meetings that have occurred in 2026, as well as the date of Kevin Warsh’s ascension to the chairmanship of the Fed. While there is little in this graph to indicate that the meetings or the changing of the guard at the top had a material impact on treasury rates, the divergence in rate movement across maturities has removed the kink (at the 2-year maturity) at the start of the year and made the yield curve more upward sloping:

US Treasury Department

A Longer Term Perspective on Interest Rates

    To put the increase in rates, especially long term, during 2026 in context, I looked at movements in 3-month, 10-year and 30-year rates between 1962 and the start of September 2026, with the caveat that the 30-year rate series is available only since the mid-1970s.

Federal Reserve Data (FRED)

As you look at the entire time period, you can see the trauma of the 1970s, a decade where interest rates rose to levels not seen in the US in a century, and peaking in 1981, as the Fed struggled to put the inflation bogeyman back into the closet. While rates did come down from those highs, they stayed in the 8-9% range in the second half of the 1980s, and in the 6-8% range in the 1990s  with the dot-com boom operating as a ballast. In the first decade of this century, ten-year rates declined below 5% in 2002, but stayed in the 4-5% range until 2008, when the financial crises drove rates below 4%. In the last decade (2011-2020), rates trended down, dropping below 3% in 2011 and staying in the 2-3% range for most of the period, with the Fed lending a helping hand. The economic shutdown in 2020, after COVID, pushed long term rates below 1% for the first time in history, and rates stayed low in 2021. The extended stretch of low interest rates from 2009 to 2021 was broken in 2022, when the ten year rate more than doubled, from 1.52% to 3.88%, and rates since have largely stayed in the 4-4.5% range, with the 4.75% rate in September 2026 representing a breakout. The graph also includes the 3-month treasury bill rate, and it moves largely with the 10-year rate, albeit with bigger swings, and rates close to zero for much of the last decade, and the 30-year treasury rate, which has generally traded at slightly above the 10-year rate, with the difference widening in September 2026.

The Drivers of US Interest Rates

    In my prior posts on interest rates, I have argued that the focus among many investors and market-watchers on the Federal Reserve as the all-powerful force moving interest rates has diverted attention from the fundamentals that move rates over time. The first of these fundamentals is inflation, with higher expected inflation manifesting as higher rates, and the second is a real interest rate, which at least in the long term, you can proxy with real growth in the economy. One of the indicators that I track is what term an "intrinsic riskfree rate", which I obtain by summing up the inflation rate and real GDP growth in the US economy each year. Financial markets have minds of their own, and the observed rates are a function of demand and supply:

If your pushback is that actual inflation is a noisy estimate, and that expected inflation is anyone's guess, you are right, but for much of this century, we have had market estimates of expected inflation, that can be obtained from the US treasury market, by comparing the 10-year US treasury yield to the yield on a ten-year US TIPs (inflation-protected rate):

Federal Reserve Data (FRED)

The expected inflation numbers embedded in the US treasury market show a market that is less swayed by year-to-year changes in inflation than more by long term expectations, with a dip in expected inflation between 2008 and 2021, and an increase in expected inflation estimates, starting in 2022.  It is interesting that notwithstanding the surge in oil prices this year, and the increased talk of inflation, there has been only a very mild increase in the long-term expected inflation rate, as calculated using yields on treasuries at the start of September 2026.

    In the graph below, I use the actual inflation rates and real GDP growth rates for the US, going back to 1962, and compute the intrinsic 10-year treasury rate (the cumulative column) and actual 10-year treasury rate each year:

Federal Reserve Data (FRED)

The graph tells the interest rate story well, as the surge in inflation in the 1970s played out as higher rates (intrinsic and real) for much of that decade and the next, and the decline in inflation and anemic real growth translated into the lower rates that we observed from 2009 and 2021. When inflation surged in 2022, interest rates went up, but since the rates that I am tracking are long term rates, the intrinsic risk free rate vastly exceeded the actual rate that year, but the difference has narrowed over time, and almost dissipated by September 2026 (when the US 10-year treasury bond rate was 4.75% and and the intrinsic ten-year rates yielded 5.41%).

Government Bond Rates in Other Currencies (Countries)

   As investors focus on movements in US treasuries, interest rates have been on the move across the globe since 2021. In the graph below, I start with a look at government bond rates in five other currencies: the Euro (with the German 10-year bond rate), the Japanese Yen, the Australian and Canadian dollar and the British pound:

You will notice that the rise in rates from COVID lows (which pushed the Euro ten-year rate into negative territory) has been across the board, with rates surging in 2022. Focusing just on 2026, you see the same pattern, with rates rising across all of the currencies tracked in this graph. What about the currencies of other economies? I track ten-year government rates in four  currencies - the Chinese Yuan, the Indian rupee, the Brazilian Real and the South African Rand - in the graph below:

Here, the results are more nuanced, with no or a muted 2022 effect, and ups and downs since; rates are lower in September 2026 than they were in 2021 in three of the four currencies. 

    The convergence of government bond rates across currencies in the last few years has laid waste to the carry trade, where you borrow money in a low-rate currency and lend it out at a higher-rate currency, and the punishment meted out to its practitioners is, in my view, well deserved. The carry trade is the laziest of investment strategies, with its successes due entirely to lags in how exchange rates respond to fundamentals, and calling it an investment strategy does a disservice to investing, in general.

Interest Rate Ripple Effects

    Changes in government bond rates clearly play out in the pricing of government bonds, and returns you will earn on them, but the ripple effects play out across the rest of the market (financial and real). In this section, I will start with the corporate bond market, where the interest rate effect is dominant, before looking at equities, where interest rate effects are more nuanced. 

Corporate Bonds

    Just as governments need to borrow money to fund their expenditures, businesses also borrow money, either through bank loans or if they are positioned to do so, by issuing bonds. The rates at which businesses can borrow start with a riskfree rate in the currency as a base, with a credit spread reflecting the business borrower's default risk added on. If governments are perceived to be riskfree, the government bond rate stands in as the riskfree rate, but if they are not, the riskfree rate can be extracted from the government bond rate, by netting out the default spread for the government. That makes working with US dollars tricky, since the US lost its Aaa rating (Moody's) in May 2025, and I wrote about the consequences for computing dollar riskfree rates at the time.

   In the graph below, I look at the day-to-day movements in default spreads over the ten-year US treasury rate, across seven bond ratings classes - AAA, AA, A, BBB, BB, B and CCC & lower - in 2026: 

Federal Reserve Data (FRED)

Since default spreads are added to the US treasury rate, and the ten-year rate has risen in 2026 from 4.18% at the start to 4.75% on August 31, 2026, corporate bond rates are all higher than they were at the beginning of the year. For all of the ratings classes, other than high yield (CCC & below), spreads are largely unchanged or lower. The only ratings class where you see a surge in spreads is in the lowest rated bonds, where the default spread has increased by 1.57% during the course of the year.

    The implications for corporate borrowing and costs of capital are direct. Debt is now costlier than it was at the start of the year, for business borrowers across the world, with almost all of the increase coming from rising riskfree rates, in different currencies, with an added cost for the borrowers with the highest default risk. For bond investors, with money in long-term corporate bonds, the year has played out in lower bond prices, in both the treasury and corporate bond markets.

Note that while the returns have been low or even negative, across bond categories, the effect is nowhere near the carnage that we saw in 2022, partly because the rate change has been more muted and partly because the price effect of a rate change is much greater when rates are very low, as they were at the start of 2022.  

Stock Prices

    The essence of intrinsic value is that the value of an asset is the present value of the expected cashflows from that asset. As you take your first steps through discounted cashflow valuation, the question of what should happen to value, as interest rates increase, seems obvious. After all, as interest rates rise, discount rates should go up, and as they go up, the present value should decrease. That is, in fact, the process that I used to estimate the changes in bond value during 2026, in both US treasuries and corporate bonds. The reason that the effect of higher rates on value is direct, with bonds, is because the cash flow on a bond is the coupon and the coupon is set at the time the bond is issued, and does not change as interest rates change. With stocks, the effect of higher interest rates is not as direct for a simple reason. The expected cash flows on stocks are the residual cashflows from operations at businesses, and these residual cash flows reflect the revenues, earnings and reinvestment at these businesses. 

If, as interest rates rise, both cash flows and discount rates change, the effect of interest rates changes on equity prices requires grappling with how these interest rates changes play out in operating metrics:

• With revenues, the key determinants of how higher interest rates play out in value will depend first on why interest rates rose in the first place (higher inflation or higher real rates), and if it is higher inflation, how much pricing power a business has to pass through that inflation to its customers.
• With earnings, the question is how higher interest rates play out in profit margins, through their effects on costs of goods sold (gross), other operating expenses (operating) and interest expenses (net).
• When interest rates rise, and that rise is due more to real rates rising rather than inflation going up, businesses can scale back reinvestment, since fewer investments will generate the returns needed to pass muster. This reduction in reinvestment can increase near-term cashflows, at the expense of future growth.

The effects of higher interest rates will therefore vary across companies, with some companies seeing decreases in value (as the discount rate effect dominates any cash flow effects), some seeing no impact (as the discount rate and cash flow effects cancel out), and some benefiting with higher value, because their cash flows rise more than enough to compensate for higher discount rates:

The effect on equities, in the aggregate, will depend on the composition of the market, and which of the three groups (companies hurt by. not affected by or helped by) dominates. There is the added complication of risk premiums (equity risk premium and bond default spread) being affected by higher rates, adding to the discount rate effect.

As you can see, the question of how higher interest rates will play out in stock prices, will vary across different equity markets, and with any given market, it will vary across time. As US treasuries have risen in 2026, US equity indices have, for the most part, taken that increase in stride, with the S&P 500 and NASDAQ both rising strongly over the first eight months of the year:

To zero in on the interest rate effect, I looked at the yield on the 10-year US treasury bond, by day, during 2026. Of the 169 trading days of the year, from January 1 through August 31, 2026, there have been 84 days when yields increased, 73 days that they decreased and 12 days where they remained unchanged, and I looked at S&P 500 average daily returns for each group:

Were stock prices affected by changes in treasury rates during the trading day in 2026? The answer is yes, but only for larger movements in the yield (>3 basis points), with the S&P 500 down almost half a percent on days when the 10-year rate increased by more than 3 basis points and up about half a percent on days when the rate decreased by more than 3 basis points. Thus, at the risk of sounding contradictory, while stocks have held their own during 2026, in the face of rising rates, they have done much worse on days when the 10-year treasury rate went up than they did on days that rate decreased. The secret to equity resilience in the face of higher oil prices, interest rates and political turmoil has been in equity earnings, which have surged over the course of 2026. In the graph below, you can see the analyst consensus estimates of earnings for the S&P 500 for 2026 and 2027 over the course of 2026: 

Ed Yardeni

Over the first eight months of 2026, analysts who track the S&P 500 companies have raised their estimates for corporate earnings by more than 11% for both 2026 and 2027, indicating that companies are finding ways to get more to the bottom line, in the face of macro concerns and higher rates. I know that you have questions about these earnings, and I do as well, especially in the context of how companies are reporting the effects of AI on their earnings, but at least on the surface, the numbers are impressive. I plan to revisit these earnings numbers in a future post, and take a deeper look at what's driving these numbers, but for the moment, they are the reason that stocks have held their own in 2026.

Equities: Cross Company Comparisons

    While equities, at least in the aggregate, have held their value, how have higher interest rates played out across sectors? In the table below, I break down all US companies, broken down into sectors, and look at the change in aggregate market capitalization for the sector, as well as statistics on individual companies within each sector (lower quartile, median, upper quartile and percent up and down):

Source Data: S&P Capital IQ

During 2026, energy was the best performing sector, not surprising given the spike in oil prices, followed by technology, at least based upon aggregated market cap returns. The divergence between the at measure of return and the returns on the median company in the sector is a measure of how top-heavy a sector's returns are, and with technology, it is clearly the largest tech companies that are driving the returns; the median tech company had returns of only 7.75%, well below the aggregate tech sector returns of 25.22%. The worst performing sectors in 2026, at least through August, are the consumer sectors (discretionary and staple), utilities and communications, with lower pricing power and higher input costs to blame.

   Since the rise in interest rates is not restricted to the United States, I looked at the performance of equities across the globe, based upon aggregated market capitalization (in dollar terms) and looking at individual company metrics on returns:

Source Data: S&P Capital IQ

While global equity value has increased about $17 trillion (11.28%) in 2026 (through August 31, 2026), there are wide differences across regions, with Indian and Chinese equities struggling with low single digit returns, and far more stocks down than up. Some of the performance that you see in this table comes from movements in exchange rates, since regions with currencies that have appreciated (depreciated) against the US dollar will see increases (decreases) in US dollar returns.

Conclusion

    As we get closer to the FOMC meeting date, it is likely that there will more talk about interest rates, and what the Fed can or cannot do to change their course. Much of that debate, in my view, is pointless, since the pathway of rates is and will continue to be set by fundamentals. In fact, the ten-year US treasury rate has been stuck in a fairly tight range, between 4% and 5%, since 2022, and that is largely because expected inflation has settled in at about 2.5%, even as actual inflation has remained volatile. For rates to change significantly, up or down, there has to be a break in inflation expectations, to the up or downside, and there is little that Kevin Warsh or Scott Bessent can do to alter that trajectory. As to how equity markets and businesses are dealing with higher rates, the pain from moving from a low-rate to a high-rate world was most acutely felt in 2022, and both have adapted quickly to the new environment, with businesses finding ways to deliver higher earnings in the face of higher rates, and markets pricing in these earnings to deliver solid returns. 

YouTube Video

Data Links

1. US Treasury Rates, Corporate Bond Spreads and Equities in 2026 (1/1/26-8/31/26)
2. US Treasury Rates: Intrinsic vs Actual 10-year Rates (1954 to 2026)