Can Stocks Keep Climbing as Rates Rise?

Key takeaways

• Stocks continue to climb despite rising rates. The S&P 500 has extended its winning streak to eight weeks, even as yields move back toward recent highs, underscoring the strength of the rally.
• Higher yields reflect both positive and more challenging forces. Resilient growth, strong investment, and improving productivity are pushing rates higher, alongside renewed inflation concerns, Fed uncertainty, and rising government debt.
• This is not a repeat of 2022. Policy is already restrictive, the labor market is more balanced, and fiscal support is less stimulative, suggesting the Fed can afford to be more patient.
• Earnings remain the key support. Strong corporate profits, particularly in AI-driven sectors, continue to underpin equities, even as higher rates may pressure valuations and increase volatility.
• Stay balanced and opportunistic. We favor a mix of large-cap tech and more cyclical exposures, while using short-term bonds to capture attractive yield pickup over cash without taking on significant duration risk.

After seven straight weeks of gains that lifted the S&P 500 by roughly 17%, stocks finished higher again last week, extending the winning streak to eight, the longest stretch since 2023, even as bond yields continued to move higher. The resilience of the rally is encouraging, but the rise in rates adds another brick to the market’s wall of worry.

So far, equities have leaned on an earnings-powered, tech-led advance, while bond markets have focused more on risks tied to higher oil prices, sticky inflation, government debt, and uncertainty around the Fed’s next move. But with yields approaching levels that have triggered bouts of equity volatility in recent years, investors are asking a reasonable question: how much higher can rates go before they begin to weigh on the rally?

We offer the following perspective on why yields are rising, why today’s inflation backdrop differs from 2022, and what higher rates may mean for portfolios.

What's driving yields higher?

Since the beginning of March, the 10-year Treasury yield has risen from around 4.0% to 4.6%, near the top end of its three-year range. Longer-term yields are also moving higher globally, with the 30-year Treasury yield at its highest level since 2007 and long-term yields in Japan and the U.K. near multi-decade highs.

We think the move reflects both “good” drivers, including resilient growth, stronger investment, and improving productivity, and “bad” drivers, including renewed inflation pressure, rising government debt, and uncertainty around monetary policy.

1. Renewed inflation concerns and Fed repricing
   
   Higher energy prices are adding upward pressure to inflation. Headline CPI rose 3.8% in April, the fastest pace since 2023, while producer prices increased 6%. Core inflation has also firmed, suggesting price pressures may not be limited to volatile energy prices alone. 
   
   For bond investors, stickier inflation reduces confidence that the Fed can ease soon and raises the risk that rates stay elevated for longer. Earlier this year, investors were largely focused on the timing and magnitude of potential Fed rate cuts. Since the conflict started, market pricing has shifted toward the possibility of a rate hike by January, contributing to the broader move higher in yields.
    
2. Resilient economic growth
   
   The economy has remained stronger than many expected. Despite ongoing geopolitical uncertainty in the Middle East, consumers continue to spend, businesses are investing heavily in AI, and corporate profits are booming. Productivity has been on the rise and timely indicators of economic activity, including the Dallas Fed Economic Index and the Atlanta Fed’s GDPNow model, point to a solid quarter. 
   
   This is the more constructive side of the rise in yields. Stronger growth and better productivity can raise expectations for the economy’s long-run growth potential. If the economy can continue expanding without meaningful Fed support, policy rates may not need to fall as much as previously expected. 
    
3. Global pressures 
   
   The rise in bond yields is not just a U.S. story. Similar moves have occurred across several major markets. In Europe, the European Central Bank is expected to raise rates next month in response to rising inflation. In Japan and the U.K., the increase in long-term yields has been driven in part by concerns over government debt and fiscal policy.
   
   Bond investors are increasingly pushing back against the possibility of additional fiscal stimulus as governments seek to offset the impact of high energy prices on households. Higher deficits and increased issuance may require higher yields to attract buyers, especially at the long end of the curve.

Why today’s inflation setup differs from 2022

The recent acceleration in the CPI, along with the Fed minutes showing that some officials would consider rate hikes if inflation remains elevated, may bring back uncomfortable memories of 2022. That was the last time the Fed had to respond to high inflation with aggressive rate hikes, a tightening cycle that ultimately contributed to a bear market in stocks.

However, we think there are several important differences between today’s inflation backdrop and the one investors faced in 2022. Those differences suggest that the Fed’s playbook is unlikely to be the same.

• Monetary policy is not easy.  In 2022, the Fed funds rate was near zero while headline CPI was moving toward 9%. Today, policy rates are matching inflation, giving the Fed less urgency to respond aggressively to every upside surprise.
• The labor market is no longer overheated. In 2022, job openings were roughly twice the number of unemployed workers and wage growth was accelerating. Today, unemployment remains low, but hiring has slowed and wage growth is not reaccelerating in a way that would meaningfully push services inflation higher.
• Fiscal support is less stimulative. Post-pandemic stimulus boosted demand in 2022 while supply chains were still constrained. Today, fiscal support is much more limited, even as larger tax refunds are helping households absorb higher energy costs.

For these reasons, we think the Fed will remain vigilant but is unlikely to overreact to what may prove to be a temporary, energy-driven inflation spike that is largely outside of the Fed's control. Before the conflict, global oil supply was exceeding demand. If conditions normalize around the Strait of Hormuz, oil prices could retrace toward prior levels, helping ease some of the recent pressure on headline inflation.

Our base case is that the Fed stays on hold this year. We no longer expect near-term cuts, but we still think the bar for rate hikes is high.

What are the portfolio implications?

The rise in yields is approaching levels that could begin to weigh on equity performance, especially after a strong two-month run. Higher rates can pressure valuations, make bonds more competitive with stocks, and test the rally.

That said, we do not think the move is enough to derail the bull market. Part of the rise in yields reflects solid growth, stronger investment demand, and improving productivity. Meanwhile, earnings remain the key support for equities, with first-quarter profits rising at the fastest pace since 2021.

The main blemish is narrow leadership. Parts of technology may be due for a breather, while small caps could lag if rates rise further. We continue to favor U.S. large- and mid-cap stocks, combining exposure to AI-driven mega-cap growth with more cyclical sectors that trade at lower valuations and are well represented in the mid-cap space.

In fixed income, the rise in yields is a double-edged sword. Higher yields have pressured near-term returns, with U.S. investment-grade bonds now down for the year, but they also create opportunities for investors seeking income. We see value in short-term bonds, where the yield pickup over cash is compelling without taking on significant duration risk. For example, 2-year Treasury yields offer roughly a 0.45% advantage relative to 3-month Treasury bills, a proxy for money market rates.

We do not think it is time to meaningfully extend duration yet, given still-firm inflation, resilient growth, and government debt concerns. However, elevated long-term yields may provide a more attractive starting point if conditions begin to shift, particularly if inflation cools on a potential peace deal with Iran or growth momentum slows.

Bottom line: We are keeping a close eye on bond yields, as a material move higher could affect valuations. But at current levels, we think the rise in rates is more of a source of discomfort than a reason to abandon equities. In our view, diversification remains a friend in this environment, and we would use periods of market weakness as opportunities to add selectively as overbought conditions ease.

Angelo Kourkafas, CFA

Senior Global Investment Strategist

^{Source for all data in commentary: Bloomberg, FactSet}

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