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Rising interest rates can hurt both bonds and stocks, but through different channels. Existing fixed-rate bond prices generally fall when comparable market yields rise. Stocks can also lose value because higher discount rates reduce the present value of expected profits, yet earnings growth, risk premiums, starting valuations and the reason rates are rising can offset or amplify that pressure. Neither asset class has a guaranteed outcome in every rising-rate period.
What changes when interest rates rise?
“Interest rates” can mean several different things. A central bank’s policy target is a very short-term rate. The yields investors demand on two-year, 10-year or 30-year Treasury securities are market rates that incorporate expectations for future short-term rates, inflation, real economic growth and term premiums. Corporate borrowing rates also include compensation for credit and liquidity risk.
That distinction matters because a policy-rate increase does not mechanically determine every asset price. Long-term yields can rise even when markets are reacting to expected future policy, fiscal risks or a higher term premium. In a February 12, 2026 Federal Reserve note, Daniel Covitz and Eric Engstrom attributed a specified recent increase in far-forward nominal Treasury rates to heightened perceived risks of future adverse economic supply shocks and greater concerns about future federal deficits. They reported no evidence that increased far-ahead inflation risk explained that episode. Their analysis is about that particular period, not a universal explanation for every yield move.
When far-forward rates rise, long-term Treasury yields and current long-term borrowing costs for households and businesses can rise as well. The same market move can affect bonds directly through repricing and affect stocks indirectly through valuation, financing conditions and expected business results.
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Why do existing bond prices generally fall when yields rise?
Fixed cash flows must compete with new bonds
A conventional fixed-rate bond promises specified coupon payments and repayment of principal at maturity. Suppose an older bond pays a 3% coupon while newly issued bonds of similar maturity and credit quality offer a 5% yield. Investors will generally pay less for the older bond so that its remaining coupons and principal produce a market yield closer to 5%.
This is an inverse relationship between price and yield: all else equal, a higher required yield means a lower present price for the same contractual cash flows. The price adjusts in the secondary market; the issuer usually does not change the original coupon.
The Federal Reserve documented this mechanism during 2022, when yields increased and prices of long-term Treasury securities declined. That observation describes a U.S. episode, not a fixed percentage loss that applies to every bond or every rate cycle.
Timing of cash flows determines rate sensitivity
Bonds whose cash flows arrive farther in the future are usually more sensitive to a given yield change. A long-maturity, low-coupon bond has more value tied to distant payments than a short-maturity bond, so its price can move more for the same change in market yield. Professionals summarize this exposure with duration, which approximates the percentage price change for a one-percentage-point change in yield, with the sign reversed. Convexity describes how that sensitivity changes as yields move.
A short-term Treasury bill may mature soon and therefore have limited price sensitivity to a rate move, while a 30-year fixed-rate bond can experience a much larger mark-to-market change. The comparison assumes similar credit quality and that the yield change applies to the relevant maturity.
Rate risk is not the same as credit risk
A Treasury bond can lose market value because its yield rises even when investors still expect full repayment. A corporate or municipal bond also carries the possibility that the issuer’s financial condition deteriorates, causing its credit spread to widen or a default to become more likely. Credit spreads are the extra yields investors demand over comparable-maturity Treasuries.
Floating-rate loans have a different exposure. Their coupons reset with a reference rate, so rising short-term rates can increase the borrower’s interest bill. The loan’s price can still fall if credit risk, liquidity concerns or a required spread increases. The Federal Reserve’s July 2026 Monetary Policy Report said debt-servicing capacity was lower for some non-investment-grade public firms and riskier private firms, particularly those reliant on floating-rate debt.
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Holding a bond to maturity does not remove every risk
If an investor holds an individual bond to maturity and the issuer makes every promised payment, the contractual principal and coupons are known in advance. Daily market-price declines then may not change those scheduled cash flows. However, holding to maturity does not eliminate default risk, reinvestment risk, inflation risk, liquidity risk or the opportunity cost of owning a below-market coupon while newer securities pay more.
Bond funds and exchange-traded funds generally do not have a single maturity date for the entire portfolio. Their net asset values continue to reflect market yields, maturities, credit conditions and portfolio turnover, so a temporary price decline is not automatically reversed by waiting for one maturity date.
Why can stocks fall when interest rates rise?
Higher discount rates reduce the present value of future profits
Stocks represent claims on uncertain future earnings, dividends and other business cash flows rather than fixed payments. Investors value those expected payoffs by discounting them back to the present. When the discount rate rises, the present value of an unchanged stream of future cash flows falls.
The Federal Reserve’s May 2021 Financial Stability Report states: “According to a long-standing theory, an asset’s price should equal the expected discounted value today of future payoffs from holding assets—for example, interest payments on Treasury securities and corporate bonds as well as dividends from stocks.” This framework applies to both fixed-income and equity valuation, even though the cash flows and risks differ.
Companies whose expected profits are concentrated many years in the future can be more sensitive to discount-rate changes than businesses producing substantial current cash flow. That is a valuation characteristic, not a guarantee about how any particular stock will perform.
Investors compare stocks with safer alternatives
When Treasury yields rise, investors can obtain a higher return from an asset generally viewed as having lower default risk. To keep holding a risky stock, they may require a higher expected return, often described through the equity risk premium. If expected earnings do not increase enough to justify the new required return, the stock price may adjust downward.
But the equity risk premium is not fixed, and a rate increase can occur alongside stronger economic growth. If higher rates reflect improving demand and investors raise their earnings forecasts, stocks may hold up or rise despite valuation pressure. Federal Reserve staff describe asset prices as depending on expected future payoffs, interest rates, risk premiums or a combination of those inputs.
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Corporate financing and operating effects matter
Higher rates can raise interest expense for companies with variable-rate debt or upcoming refinancing needs. They can also reduce customers’ ability to finance purchases, weaken housing or business investment, and slow overall demand. Conversely, a company with substantial cash reserves may earn more interest income, and a bank’s results can respond differently from those of a highly leveraged borrower.
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Therefore, “stocks fall when rates rise” is too broad. The outcome depends on each company’s balance sheet, pricing power, revenue sensitivity, debt maturity schedule and expected earnings, as well as the market’s starting valuation.
Stocks and bonds can decline at the same time
Investors sometimes expect bonds to rise whenever stocks fall. That relationship is not guaranteed. If a shock pushes both discount rates and risk aversion higher, both asset classes can lose value.
The Federal Reserve’s 2022 annual financial-stability report described such an episode in the United States. Amid persistently high inflation and a tight labor market, monetary policy tightened while the economic outlook deteriorated. Long-term Treasury yields rose notably; long-term Treasury prices and leveraged-loan prices declined; broad equity indexes declined; and corporate bond spreads widened during the first half of the year before narrowing slightly toward year-end.
This example does not show that all bonds fall equally, that every stock declines during a tightening cycle or that the same stock-bond correlation will recur. Maturity, credit quality, company fundamentals, starting valuations and the reason yields rise all influence the result.
Policy rates, Treasury yields and term premiums
Short-term policy decisions
A central bank controls or guides a short-term policy rate. Changes affect overnight funding, floating-rate borrowing and expectations for future short-term rates. Markets may price those expectations before an official decision is announced.
Long-term Treasury yields
A long-term Treasury yield can be viewed as a combination of expected future short-term rates and a term premium: the additional compensation investors require for holding a longer-maturity security whose value is exposed to uncertainty over time. Inflation expectations, real-rate expectations, fiscal concerns, supply and demand for duration, and risk sentiment can all affect that premium.
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Consequently, a policy-rate increase may be accompanied by a smaller long-term-yield move, a larger move or even a decline in a particular long-term yield if markets revise their outlook for future growth and inflation. The reverse can also occur: long-term yields may rise because term-premium risks increase even without a matching change in the policy target.
Comparing stock and bond exposures
| Exposure | Fixed-rate bonds | Stocks |
|---|---|---|
| What is promised? | Specified coupons and principal, subject to issuer performance and contract terms. | No fixed payment; value depends on uncertain future profits, dividends and business assets. |
| Primary rate mechanism | Market price generally moves inversely to comparable yields. | Higher discount rates can reduce the present value of expected cash flows. |
| Timing sensitivity | Longer duration and later cash flows usually increase sensitivity to yield changes. | Businesses with profits expected farther in the future can be more valuation-sensitive. |
| Credit or operating risk | Issuer default and spread risk are separate from Treasury-rate risk. | Earnings, margins, leverage, competition and economic demand drive operating risk. |
| Effect of stronger growth | Can push yields higher and prices lower, especially for longer maturities. | Can raise expected earnings and partly or fully offset valuation pressure. |
| Liquidity and horizon | Individual bonds have a maturity date; funds trade at market value continuously. | Stocks have no maturity date and remain exposed to changing expectations. |
What determines the outcome in a particular rising-rate period?
Why yields are rising
- Higher inflation expectations: Nominal yields may rise, while input costs and consumer behavior affect company profits.
- Higher real growth expectations: Stronger future demand can lift earnings forecasts even as discount rates increase.
- Tighter monetary policy: Borrowing conditions can restrain demand and increase financing costs.
- Higher term or risk premiums: Investors may demand more compensation for duration, fiscal uncertainty or adverse supply-shock risks.
The same change in a 10-year yield can therefore have different implications depending on its cause.
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Assets priced generously at the start of a rate move may have less room for disappointing news. Conversely, low starting prices can provide more cushion, though valuation measures are uncertain and are not short-term timing signals.
The Federal Reserve’s May 2026 Financial Stability Report, covering U.S. conditions and data as of April 23, 2026, said S&P 500 valuation measures were in the upper part of their historical distribution and that its estimated equity premium was low relative to its historical average. It also reported that corporate spreads over comparable-maturity Treasuries remained low by longer-run standards, while Treasury term premiums moved higher amid volatility. These are dated market observations, not forecasts or fair-value rules.
The July 2026 Monetary Policy Report likewise described equity valuations as high relative to historical distributions and noted wider spreads for speculative-grade technology bonds and leveraged loans. It identified weaker debt-servicing capacity among some publicly traded non-investment-grade firms and riskier private firms, especially those dependent on leveraged loans or private credit.
Duration, maturity and credit quality
Within bonds, a short-duration, high-quality security can respond very differently from a long-duration corporate bond. A rate increase may reduce the first security’s price modestly while a simultaneous spread widening causes a larger decline in the second. Comparing “bonds” without specifying maturity and credit quality hides these differences.
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How to interpret the 2022 episode without overgeneralizing
- Identify the starting conditions. Inflation was persistently high, the labor market was tight and policy was tightening.
- Separate market rates from policy actions. Long-term Treasury yields rose notably, which affected the prices of existing long-term Treasuries.
- Track credit separately. Leveraged-loan prices declined and corporate spreads widened in the first half of the year, showing that credit risk added to pure duration risk.
- Observe cross-asset behavior. Broad equity indexes also declined, demonstrating that stocks and government bonds can lose value together.
- Keep the episode in scope. The Federal Reserve’s relevant data extend through December 2022; the experience is evidence of one U.S. rate shock, not a universal pattern.
Understanding the Federal Reserve’s historical valuation statistic
The Federal Reserve’s 2022 annual report gives a median aggregate forward price-to-earnings ratio of 15.5 for S&P 500 firms over the figure’s 1989–2022 period, based on expected earnings 12 months ahead. It is a historical reference statistic, not a current 2026 market reading and not a universal threshold for deciding whether stocks are cheap or expensive.
Forward P/E is only one valuation measure. It depends on the earnings forecast, interest rates, risk premiums and the composition of the index. A single ratio cannot predict the direction of stocks during a particular rate cycle.
Questions investors commonly ask
Do stocks always go down when interest rates rise?
No. Higher rates can compress valuations and increase financing costs, but stronger expected earnings, changing risk premiums or a favorable economic outlook can offset those effects.
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Are bonds safer than stocks when rates are going up?
“Safer” depends on the risk being measured. High-quality bonds generally have more predictable contractual payments than stocks, but their market prices can fall when yields rise. Corporate bonds add default and spread risk, and floating-rate borrowers can face higher debt-service costs. Stocks have no maturity value and carry greater uncertainty about future cash flows.
Why can a bond fund lose money if it owns government bonds?
Government bonds can decline in market value when their yields rise. A fund continuously marks its holdings to market and may not hold every security until maturity, so its net asset value reflects those price changes.
Does holding an individual bond to maturity guarantee no loss?
No. If the issuer pays as promised, the scheduled principal and coupons may be received, but default, inflation, reinvestment, liquidity and opportunity-cost risks remain. Selling before maturity exposes the investor to the current market price.
What should I watch besides the central bank’s policy rate?
Watch the maturity-specific Treasury yield curve, inflation and growth expectations, term premiums, corporate credit spreads, company debt-servicing capacity and the valuation level at which stocks and bonds began the move. These indicators describe different mechanisms and should not be treated as interchangeable.
A practical framework for reading a rising-rate headline
- Name the rate. Is it an overnight policy target, a two-year yield, a 10-year yield, a mortgage rate or a corporate spread?
- Find the cause. Determine whether the move reflects inflation, growth, expected policy, fiscal concerns, supply shocks or a higher term premium.
- Map the cash flows. For bonds, check maturity, duration, coupon and credit quality. For stocks, assess when profits are expected and how sensitive the business is to financing costs.
- Check the starting point. High equity valuations or unusually narrow credit spreads can increase repricing sensitivity, but neither is a short-term forecast.
- Separate price from payment. A market-price decline is different from a missed contractual payment, while a stable payment does not eliminate inflation or liquidity risk.
- Use the correct geography and date. The Federal Reserve observations cited here describe U.S. markets and carry the dates stated in each report; other countries can have different policy regimes, currencies and market structures.
Bottom line
Rising rates generally pressure existing fixed-rate bond prices because new, higher-yielding securities make older coupons less attractive. Stocks face a different pressure: higher discount rates can reduce the present value of expected profits and raise the return investors demand over safer assets. Yet neither relationship is automatic. The direction of earnings, credit quality, duration, starting valuation, risk premiums and the reason yields rise determines whether stocks, bonds or both decline in a particular period.
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