Interest rates, inflation and the stock market: how they affect your investments
By the MeridIAn Screener team · Published on 13 October 2026 · 7 min read
Few numbers move markets as much as the interest rate set by a central bank. It decides what a mortgage costs, what a savings account pays, what a bond is worth and, less obviously, how much the market is willing to pay for a stock. Here’s how it works, what it has to do with inflation and why the difference between nominal and real rates matters.
What an interest rate is and who sets it
An interest rate is the price of money: what a borrower pays and what a lender earns, as a yearly percentage. If you borrow $10,000 at 5%, you pay $500 a year to use it.
There are many rates, but almost all of them hang off one: the policy rate of the central bank. In the US, the Federal Reserve (the Fed) sets a target range for the federal funds rate, the rate at which banks lend to each other overnight. In the euro area, the European Central Bank (ECB) does the same with its own rates.
From there the effect passes down the chain:
| From the policy rate… | …to | What you notice |
|---|---|---|
| Federal funds rate | Prime rate (what banks charge their best customers) | Credit cards, home equity lines and other variable loans |
| Fed rate and expectations | Treasury yields | What T-bills and bond funds pay, and the rate on 30-year fixed mortgages |
| Fed rate and competition | Savings accounts, money market funds and CDs | What you earn on your cash (banks follow with a delay) |
| Treasury yields | Corporate borrowing costs | Earnings and dividends of indebted companies |
Inflation, the reason rates move
Inflation is the general rise in prices. In the US it’s measured by the Consumer Price Index (CPI), published by the Bureau of Labor Statistics, and by the PCE price index, which is the one the Fed targets. Core inflation leaves out food and energy, because their prices jump around a lot from month to month.
The Fed aims for 2% inflation over time. When prices rise clearly above that, it raises rates: credit gets more expensive, people borrow, spend and invest less, and the pressure on prices cools. When the economy slows and inflation falls below target, it does the opposite.
The recent episode: after the pandemic and the war in Ukraine, US CPI inflation reached 9.1% in June 2022, the highest since 1981. The Fed raised the federal funds rate from near zero to 5.25-5.50% between March 2022 and July 2023, its fastest hiking cycle in decades. The ECB did something similar in Europe, where inflation peaked at 10.6% in October 2022.
The mechanism has a problem: it’s slow. A rate hike takes one to two years to fully show up in prices, so central banks decide by looking ahead, and sometimes they overshoot or fall short.
Nominal and real rates: what matters is what you keep
The nominal rate is the one you see advertised. The real rate is what you actually earn after inflation, because your money buys less each year. Roughly:
real rate ≈ nominal rate − inflation
| Situation | Nominal rate | Inflation | Real rate | What happens to $10,000 |
|---|---|---|---|---|
| Savings account in a year of stable prices | 2% | 0% | +2% | You can buy 2% more than before |
| Savings account in a year of high inflation | 3% | 5% | −2% | You buy 2% less, even with $10,300 |
| Checking account paying nothing, moderate inflation | 0% | 3% | −3% | You lose about $300 of purchasing power |
The exact formula is (1 + nominal) ÷ (1 + inflation) − 1, but with small numbers the subtraction is enough. Real rates are what really drive decisions: with negative real rates, holding cash is costly and buying assets (stocks, real estate, gold) looks attractive; with high positive real rates, risk-free savings compete with stocks again. Treasury Inflation-Protected Securities (TIPS) show the market’s real rate directly.
Why rates move the stock market
A stock is worth what the profits the company will generate in the future are worth today. To add up money from different years you have to discount it: $100 ten years from now isn’t worth $100 today, and the higher the interest rate, the less it’s worth.
Example: $100 you’ll receive in 10 years is worth $82 today if the interest rate is 2%, but only $61 if it’s 5%. The same cash flow is worth 25% less just because the discount rate changed.
That leads to three effects that add up:
- Valuation. With high rates, the market pays less for each dollar of earnings: P/E ratios fall. It hits hardest companies whose profits lie far in the future (fast growers).
- Competition. A stock’s earnings yield is 1 ÷ P/E: with a P/E of 25 it’s 4%. If a Treasury bond with almost no risk pays 4%, the stock has to offer something more to make up for its risk. With bonds at 0%, almost any stock looked cheap.
- Profits. Indebted companies pay more interest and earn less; consumers with variable-rate debt spend less.
In 2022, as rates rose, the S&P 500 fell 19% and the tech-heavy Nasdaq 33%. But it isn’t a law of physics: if rates rise because the economy is doing very well, earnings can grow more than valuations lose.
Who wins and who loses when rates rise
Not every company reacts the same way. Common tendencies, not rules:
| Type of company | With rising rates it tends to… | Why |
|---|---|---|
| Banks | Benefit, up to a point | They earn more on loans than they pay on deposits. If rates rise too much, bad loans grow |
| Insurers | Benefit | They reinvest premiums in bonds that pay more |
| Fast-growing tech companies | Suffer | Their value depends on distant profits, which are discounted more |
| Real estate (REITs) and utilities | Suffer | Lots of debt, and their dividends compete with bonds |
| Consumer discretionary (cars, leisure, luxury) | Suffer | Households with debt spend less |
| Companies with net cash | Hold up better | They don’t depend on credit and earn interest on their cash |
Every MeridIAn company page shows net debt/EBITDA: how many years of operating profit the company would need to repay its debt. It’s the quickest way to see who is exposed to rates. We explain it in the key metrics to analyze a stock.
Bonds, savings and mortgages
Bonds. When rates rise, the price of existing bonds falls, because new ones pay more. In 2022 the benchmark US bond index (Bloomberg US Aggregate) lost 13%, its worst year on record. We go through the numbers in how the bond market works.
Savings. Banks raise what they pay on deposits later and by less than the Fed raises rates, and cut it sooner. Money market funds and T-bills usually follow the Fed more closely. It pays to compare.
Mortgages. Most US mortgages are 30-year fixed, whose rate follows the 10-year Treasury yield more than the Fed. It went from around 3% in 2021 to above 7% in 2023.
Example: a $400,000, 30-year fixed mortgage costs about $1,686 a month at 3% and about $2,661 at 7%. That’s $975 more every month that a new homebuyer can’t spend on other things, and many company sales feel it. It also explains why many owners with a 3% mortgage don’t want to move.
What an investor can do
- Don’t try to guess the next decision. The market already prices in what it expects; surprises are what move prices.
- Think in real terms. 3% with 4% inflation is losing money.
- Look at companies’ debt. With high rates, heavily indebted ones are the most fragile.
- Diversify across sectors. Rates punish and reward different sectors.
- If you own bonds or bond funds, know their duration. It tells you how much they can fall if rates rise.
- The interest rate is the price of money; the Fed raises it to curb inflation and cuts it to support the economy.
- What matters is the real rate: the nominal rate minus inflation.
- Higher rates lower valuations (especially of growth stocks), push down the price of existing bonds and make mortgages more expensive; banks and insurers tend to hold up better.
Keep reading
General information for educational purposes. Not financial or tax advice, nor a recommendation to buy or sell securities. Investing in shares involves the risk of loss. · Contact: info@meridianscreener.com