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 has raised rates again after several years.

At the September meeting, the Federal Reserve raised the target range for the federal funds rate by 25 basis points to 3.75%–4.00%. The backdrop behind this decision is not complicated: inflation is still above the target, energy prices have started rising again, and the U.S. labor market has not yet shown clear signs of deterioration.

For investors, the more important question isn’t “how much was added this time,” but rather: if the United States re-enters a high-interest-rate environment, where will stocks and bonds go from here?

The answer provided by Kristy Akullian, Head of iShares investment strategy for BlackRock Americas, in the latest report is not pessimistic. Historically, the first rate hike does not necessarily mean stocks and bonds will fall. On the contrary, as long as the economy remains resilient and interest-rate volatility stays under control, investment opportunities can still emerge in a high-rate environment.

Below is a compilation of the original text:

The Fed has restarted rate hikes.

In September, the Fed raised the target range for the federal funds rate by 25 basis points to 3.75%—4.00%, the first rate hike since July 2023.

BlackRock believes there are mainly three reasons behind this round of rate hikes: overall inflation remains elevated, rising energy prices have renewed upward pressure on prices, and the U.S. job market still shows resilience.

As a result, the Fed still has room to keep suppressing inflation without needing to worry immediately about a clear deterioration in the economy and employment.

But for the market, a more important question has emerged: if rates rise again, will stocks and bonds necessarily fall too?

BlackRock’s answer is: not necessarily.

Rate hikes do not necessarily mean stocks and bonds will both fall.

Markets typically interpret rate hikes as a negative.

The logic is straightforward. After rates rise, companies’ financing costs increase, which may suppress stock valuations; at the same time, rising bond yields can also lead to falling prices for existing bonds.

But based on historical data, there is not such a direct relationship between rate hikes and asset declines.

BlackRock analyzed seven Federal Reserve rate-hike cycles since 1983. The results show that in the 12 months following the first rate hike, U.S. stocks rose on average by 4.7%, U.S. bonds by 3.07%, and high-yield bonds by 4.68%.

Of course, this does not mean that “rate hikes are good for the market.” More precisely, a single rate hike by itself cannot determine the direction of asset prices over the next year.

The Fed typically hikes when the economy is still relatively strong. If corporate earnings are still growing and the job market has not deteriorated meaningfully, then the economy’s own growth momentum may offset some of the pressure brought by higher interest rates.

So, compared with the simple question of whether rate hikes are a headwind or a tailwind, the more important issue is actually this: why is the Fed hiking? And can the economy withstand higher interest rates?

For bonds, higher rates also mean higher yields.

One of the biggest differences this rate-hike cycle has compared with the past few years is that bonds themselves can already provide higher interest income. BlackRock believes that the currently higher risk-free rate and real yields offer a more attractive starting point for fixed-income assets.

In other words, even though rising rates may weigh on the prices of existing bonds, investors who are preparing to buy new bonds may be able to earn higher yields.

Therefore, high 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 bonds, and it emphasizes earning returns through coupon payments rather than overbetting on bond price appreciation.

However, large issuance of U.S. Treasuries and corporate bonds could still push up long-term yields. Therefore, BlackRock believes investors should not simply bet on a rapid decline in long-end rates; instead, they need to manage bond maturities more flexibly.

Notably, long-term real yields are already at relatively high levels. BlackRock points out that the real yield on the 30-year U.S. inflation-protected Treasury (TIPS) has already exceeded 3%.

This means that even without relying on a sharp rise in bond prices, long-term bonds themselves are starting to provide relatively attractive real returns.

What the U.S. stock market truly fears may not be high interest rates.

Compared with bonds, stocks face issues that are somewhat more complicated.

BlackRock remains relatively constructive on U.S. equities. Its rationale is that U.S. corporate earnings are still strong, and historically, stocks do not automatically enter a falling cycle just because the Fed’s first hike occurs.

BlackRock’s data shows that over the past seven rate-hike cycles, the S&P 500 still generally tended to rise in the 12 months after the first rate hike.

But there is a very important caveat here: rates cannot swing wildly. Markets can actually gradually adapt to a higher but relatively stable interest-rate environment. For example, if investors already believe policy rates will remain around 4% for a period of time, then that level will eventually be reflected in stock valuations and companies’ financing costs.

What really gets tricky is that the market keeps reassessing just how high rates need to go. If inflation keeps coming in above expectations and investors keep raising their expectations for future rates, and long-term Treasury yields rise quickly, then stock valuations would also need to be constantly re-adjusted.

So what BlackRock really cares about is not just whether interest rates are high, but whether rates could suddenly experience a large surge in volatility.

In this environment, BlackRock prefers large-cap companies with higher earnings quality that can reliably pay dividends, and it is relatively cautious about small-cap stocks that are more sensitive to financing costs.

Buying stocks and bonds together may not be able to diversify risk the way it did in the past.

Another thing that is changing is the relationship between stocks and bonds.

The traditional 60/40 portfolio became popular for one key reason: in the past, stocks and bonds often hedged each other. When the economy worsened, stocks typically fell; at the same time, the Fed might cut rates, and bond prices could rise—offsetting some of the losses in stocks. But over the past few years, this relationship has become less stable.

According to data from BlackRock and Morningstar, from 2010 to 2019 the correlation coefficient between stocks and bonds was about -0.22; since 2020, that figure has risen to 0.51. In other words, in recent years, it has become more common for stocks and bonds to rise (or fall) at the same time.

The reason is that the main risks facing the market have changed.

If the market’s biggest concern is an economic recession, then when stocks fall, bonds typically benefit. But if the market’s biggest concern is inflation, the situation could be completely different: rising inflation pushes rates higher, causing bond prices to fall, while higher rates also weigh on stock valuations.

That is also why BlackRock believes the traditional “stocks + bonds” mix may no longer be as stable as it used to be. It may be necessary to add other income sources from different assets or strategies to further diversify risk.

Next, it’s not only about whether the Fed will keep hiking.

BlackRock’s baseline view is that the Fed may hike one more time in 2026, but it does not currently believe this will turn into a very aggressive hiking cycle.

For the market, what may be truly worth watching next may not be “one more hike or two,” but three more important variables.

First is whether inflation will continue to rise.

If energy prices gradually fall and inflation cools again, the pressure on the Fed to keep hiking would decrease; conversely, if inflation spreads further, the market may still need to raise its expectations for interest rates.

Second, whether the economy and corporate earnings can withstand high interest rates.

Historically, after rate hikes, stocks often continued to rise when the economy was still growing. If employment, consumption, and corporate earnings all weaken noticeably at the same time, then the value of past historical experience as a guide would likely diminish.

Finally, and most importantly in BlackRock’s report: what truly deserves concern may not be high rates, but the possibility that rates suddenly become very unstable.

If the economy remains resilient and the market can gradually adapt to a higher but stable interest-rate environment, stocks could still rise and bonds can rely on higher coupons to provide returns. But if inflation re-accelerates—prompting the market to keep adjusting its rate expectations upward and pushing long-term yields quickly higher—then both stocks and bonds could face renewed pressure.

So what this rate-hike cycle is really about is not just when the Fed might act next. More importantly: can high rates stay stable, and how long can the U.S. economy endure them?