Original title: First Fed rate hike in years: What it may mean for investor portfolios
Original author: Kristy Akullian
Editor's note: The Federal Reserve raised interest rates again after several years.
At its September meeting, the Fed raised the target range for the federal funds rate by 25 basis points to 3.75%-4.00%. The background behind this decision is not complicated: inflation remains above target, energy prices are rising again, and the U.S. job market has not deteriorated significantly for the time being.
But for investors, the more important question is not "how much will be added this time", but: If the United States returns to a high interest rate environment, what will happen next for stocks and bonds?
The answer isn't doom and gloom, Kristy Akullian, head of investment strategy for iShares Americas at BlackRock, said in a new report. Historically, the first interest rate hike does not mean that stocks and bonds will necessarily fall; on the contrary, as long as the economy remains resilient and interest rate fluctuations remain controllable, investment opportunities may still arise in a high interest rate environment.
The following is a compilation of the original text:
The Federal Reserve has started raising interest rates again.
In September, the Fed raised the federal funds rate target range by 25 basis points to 3.75%-4.00%, the first rate increase since July 2023.
BlackRock believes there are three main reasons behind this interest rate hike: overall inflation remains high, rising energy prices have renewed price pressures, and the U.S. job market remains resilient.
Therefore, the Fed currently has room to continue suppressing inflation without immediate concern about a significant deterioration in the economy and employment.
But for the market, a more important question has arisen: If interest rates rise again, will stocks and bonds inevitably fall?
BlackRock’s answer is: not necessarily.
Raising interest rates does not mean that stocks and bonds will definitely fall
The market usually interprets interest rate hikes as negative.
The reason is simple. After interest rates rise, corporate financing costs will rise, and stock valuations may be suppressed; at the same time, bond yields rise, which may also cause existing bond prices to fall.
But judging from historical data, there is no such direct relationship between interest rate increases and asset declines.
BlackRock has counted seven Fed rate hike cycles since 1983. The results show that in the 12 months following the first rate hike, U.S. stocks rose an average of 4.7%, U.S. bonds rose an average of 3.07%, and high-yield bonds rose an average of 4.68%.
Of course, this does not mean that “raising interest rates is good for the market.” To be more precise, a rate hike by itself cannot determine the direction of asset prices in the coming year.
The Fed typically raises interest rates when the economy is still relatively strong. If corporate profits are still growing and the job market does not deteriorate significantly, then the growth power of the economy itself may offset part of the pressure caused by high interest rates.
Therefore, rather than simply judging whether “raising interest rates is a bad thing or a good thing”, the more important question is actually: Why does the Fed raise interest rates? Can the economy withstand higher interest rates?
For bonds, higher interest rates also mean higher returns
One of the biggest differences between this round of interest rate hikes and previous years is that bonds themselves can already provide higher interest income. BlackRock believes that the current higher risk-free rates and real yields provide a more attractive starting point for fixed income assets.
In other words, although rising interest rates may depress the prices of existing bonds, investors who are prepared to buy new bonds will also receive higher yields.
So high interest rates are not simply bad news for bonds. BlackRock currently prefers bonds with higher credit quality, including investment-grade bonds and higher-quality high-yield debt, while emphasizing generating income through coupons rather than overly betting on rising bond prices.
However, the massive issuance of U.S. debt and corporate bonds may still push up long-term interest rates. Therefore, BlackRock believes that investors should not simply bet on a rapid decline in long-term interest rates at the moment, but need to be more flexible in managing bond maturities.
It is worth noting that long-term real yields are currently at a relatively high level. BlackRock mentioned that the real yield on 30-year U.S. Treasury Inflation-Protected Securities (TIPS) has exceeded 3%.
This means that long-term bonds are starting to provide relatively substantial real returns on their own, even without relying on large increases in bond prices.
What U.S. stocks are really afraid of is not necessarily high interest rates.
Compared with bonds, the problems faced by stocks are slightly more complicated.
BlackRock remains relatively positive on U.S. stocks. The reason is that U.S. corporate earnings are still strong, and historically stocks will not automatically enter a downward cycle just because the Federal Reserve raises interest rates for the first time.
Over the past seven rate hike cycles, the S&P 500 overall remains tilted toward gains in the 12 months following the first rate hike, according to BlackRock data.
But there is a very important premise here: interest rates cannot fluctuate wildly. The market can actually slowly adapt to a higher but relatively stable interest rate environment. For example, if investors already believe that the policy interest rate will remain at around 4% for some time to come, then this level will eventually be gradually reflected in stock valuations and corporate financing costs.
The real trouble is that the market keeps reassessing how high interest rates will go. If inflation repeatedly exceeds expectations, investors continue to raise their expectations for future interest rates, and long-term U.S. bond yields rise rapidly, then stock valuations will also need to be constantly readjusted.
Therefore, what BlackRock is really concerned about is not just whether interest rates are high, but whether interest rates will suddenly fluctuate significantly.
In this environment, BlackRock prefers large-cap companies with higher earnings quality and the ability to pay stable dividends, while small-cap stocks that are more sensitive to financing costs are relatively cautious.
Buying stocks and bonds together may not be able to spread risks like in the past
Another thing that's changing is the relationship between stocks and bonds.
A big reason why the traditional 60/40 portfolio is popular is that stocks and bonds have tended to hedge against each other in the past. Stocks typically fall when the economy worsens; but at the same time, the Fed may cut interest rates and bond prices rise, offsetting some of the stock losses. But over the past few years, the relationship has become less stable.
According to data from BlackRock and Morningstar, the correlation coefficient between stocks and bonds was about -0.22 from 2010 to 2019; since 2020, this number has risen to 0.51. That said, it has become more common in recent years for stocks and bonds to rise or fall at the same time.
The reason is that the main risks faced by the market have changed.
If the market's biggest concern is a recession, bonds often benefit when stocks fall. But if the market's biggest concern is inflation, the story could be completely different: rising inflation would push interest rates higher and bond prices lower, while higher rates would also drive down stock valuations.
This is why BlackRock believes that the traditional "stock + bond" combination may not be as stable as in the past, and other assets or strategies with different sources of income need to be added to further diversify risks.
Next, it’s not just about whether the Fed will raise interest rates
BlackRock's baseline judgment is that the Federal Reserve may raise interest rates once more in 2026, but currently does not believe this will develop into a very aggressive interest rate hike cycle.
For the market, what is really worth observing next may not be “one or two more interest rate hikes”, but three more important variables.
The first is whether inflation will continue to rise.
If energy prices gradually fall back and inflation cools down again, the pressure on the Fed to continue raising interest rates will decrease; conversely, if inflation further spreads, the market may need to raise its expectations for interest rates.
The second question is whether the economy and corporate profits can withstand high interest rates.
Historically, stocks still rise after interest rates are raised, which often happens when the economy is still growing. If employment, consumption and corporate profits weaken significantly at the same time, the reference value of past historical experience will also decline.
Finally, and the most important point of this BlackRock report: what really needs to be wary of may not be that interest rates are high, but that interest rates have suddenly become very unstable.
If the economy remains resilient and markets adjust to a higher but stable interest rate environment, stocks could still rise and bonds could rely on higher coupons to provide income. However, if inflation recurs, causing the market to continuously raise interest rate expectations and long-term interest rates to rise rapidly, both stocks and bonds may come under pressure again.
Therefore, what really depends on this round of interest rate hikes is not just when the Fed will act next. More important: Can high interest rates remain stable, and how long the U.S. economy can endure them.