Editor’s Note: The Federal Reserve has raised interest rates for the first time in several years.

At its 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 for this decision was straightforward: inflation remains above target, energy prices have risen again, and the U.S. labor market has not yet shown clear signs of deterioration.

But for investors, a more important question isn't "How much was added this time?"—it's: What will happen to stocks and bonds if the U.S. re-enters a high-interest-rate environment?

Kristy Akullian, Head of Investment Strategy for iShares Americas at BlackRock, offered a less pessimistic answer in her latest report. Historically, the first interest rate hike does not necessarily mean declines in stocks and bonds; on the contrary, as long as the economy remains resilient and interest rate volatility stays contained, investment opportunities can still emerge in a high-rate environment.

The following is the translated text:

The Federal Reserve has resumed raising interest rates.

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

BlackRock believes the primary reasons behind this rate hike are: overall inflation remains elevated, rising energy prices have reignited price pressures, and the U.S. labor market continues to show resilience.

Therefore, the Federal Reserve still has room to continue curbing inflation without immediately worrying about significant deterioration in the economy and employment.

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

BlackRock's answer is: Not necessarily.

The market typically interprets interest rate hikes as negative.

The reason is simple: after interest rates rise, corporate financing costs increase, which may suppress stock valuations; at the same time, higher bond yields may cause existing bond prices to fall.

However, historical data shows that there isn't such a direct relationship between rate hikes and asset declines.

BlackRock analyzed seven Fed rate-hiking cycles since 1983. The results showed that, over 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 an interest rate hike is inherently bullish for the market. More accurately, a single interest rate hike alone cannot determine the direction of asset prices over the next year.

The Federal Reserve typically raises interest rates when the economy is still relatively strong. If corporate profits continue to grow and the labor market shows no significant deterioration, the underlying growth momentum of the economy may offset some of the pressure caused by higher interest rates.

Therefore, more important than simply determining whether an interest rate hike is bullish or bearish is understanding: Why is the Federal Reserve raising rates? And can the economy withstand higher interest rates?

For bonds, higher interest rates also mean higher returns.

One of the key differences between this cycle of rate hikes and previous years is that bonds themselves are now offering higher interest income. BlackRock believes that the current elevated risk-free rates and real yields provide a more attractive starting point for fixed-income assets.

In other words, while rising interest rates may lower the prices of existing bonds, they also offer higher yields for investors looking to purchase new bonds.

Therefore, high interest rates are not solely bad news for bonds. BlackRock currently favors bonds with higher credit quality, including investment-grade bonds and high-quality high-yield bonds, while emphasizing income generation through coupons rather than relying heavily on bond price appreciation.

However, the large-scale issuance of U.S. Treasuries and corporate bonds may still push up long-term rates; therefore, BlackRock believes investors should not simply bet on a rapid decline in long-term rates but instead manage bond maturities more flexibly.

It is worth noting that long-term real yields are currently at elevated levels. BlackRock mentioned that the real yield on 30-year U.S. Treasury Inflation-Protected Securities (TIPS) has surpassed 3%.

This means that long-term bonds themselves are now beginning to offer relatively attractive real yields, even without relying on significant increases in bond prices.

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

Compared to bonds, stocks involve slightly more complex issues.

BlackRock maintains a relatively positive outlook on U.S. equities, citing strong corporate earnings in the U.S. and the historical fact that stocks do not automatically enter a downtrend following the Fed's first interest rate hike.

BlackRock's data shows that over the past seven tightening cycles, the S&P 500 has generally risen over the 12 months following the first rate hike.

But there is a very important prerequisite: interest rates cannot fluctuate sharply. The market can gradually adapt to a higher but relatively stable interest rate environment. For example, if investors already believe that policy rates will remain around 4% for the foreseeable future, this level will eventually be gradually reflected in stock valuations and corporate financing costs.

The real challenge is that the market continually reassesses how high interest rates will rise. If inflation repeatedly exceeds expectations and investors keep raising their forecasts for future rates, long-term U.S. Treasury yields will rise rapidly, forcing stock valuations to be continuously readjusted.

Therefore, what BlackRock is truly concerned about is not just whether interest rates are high, but whether they might suddenly fluctuate sharply.

In this environment, BlackRock favors large companies with high-quality earnings and the ability to consistently pay dividends, while maintaining caution toward smaller stocks that are more sensitive to financing costs.

Buying stocks and bonds together may no longer diversify risk as effectively as in the past.

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

A key reason the traditional 60/40 portfolio has been popular is that, historically, stocks and bonds often acted as hedges against each other. When the economy weakened, stocks typically fell, but at the same time, the Federal Reserve might lower interest rates, causing bond prices to rise and offsetting some of the stock losses. However, over the past few years, this relationship has become less reliable.

According to data from BlackRock and Morningstar, the correlation coefficient between stocks and bonds was approximately -0.22 from 2010 to 2019; since 2020, it has risen to 0.51. This means that in recent years, stocks and bonds have increasingly moved in the same direction—rising or falling together.

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

If the market’s primary concern is a recession, bonds typically benefit when stocks fall. But if the market’s main worry is inflation, the situation may be very different: rising inflation can push interest rates higher, causing bond prices to decline, while higher rates also depress stock valuations.

This is why BlackRock believes that the traditional "stocks + bonds" portfolio may no longer be as stable as it once was, and that adding assets or strategies with different return profiles is necessary to further diversify risk.

Next, it’s not just about whether the Fed will raise rates again

BlackRock's baseline assessment is that the Federal Reserve may raise rates one more time by 2026, but it does not currently view this as leading to a highly aggressive rate-hiking cycle.

For the market, what truly matters going forward may not be “whether there will be one more or two more rate hikes,” but rather three more important variables.

First, will inflation continue to rise?

If energy prices gradually decline and inflation cools again, the pressure on the Federal Reserve to continue raising rates will ease; conversely, if inflation spreads further, the market may need to raise its expectations for interest rates.

Second, can the economy and corporate profits withstand high interest rates?

Historically, stocks have continued to rise after interest rate hikes when the economy was still growing. If employment, consumption, and corporate profits all show significant weakening, the relevance of past historical patterns diminishes.

Finally, and most importantly, the key point of BlackRock’s report: what we should truly be wary of may not be high interest rates, but rather a sudden surge in interest rate volatility.

If the economy remains resilient and markets can gradually adapt to a higher but stable interest rate environment, stocks may still rise, and bonds can generate returns through higher coupon payments. However, if inflation persists, causing markets to continuously raise interest rate expectations and pushing long-term rates sharply higher, both stocks and bonds could face renewed pressure.

Therefore, what truly matters in this rate hike cycle is not just when the Fed will act next, but whether high rates can remain stable and how long the U.S. economy can sustain them.