What If Higher Interest Rates Are the New Normal?
After 40 years of falling rates, the investment playbook may be changing
Creed may have inadvertently written the soundtrack for today’s stock and bond market. After four decades in the relative comfort of falling interest rates, investors may be asking a familiar question: can markets take us higher even as rates move in the same direction? History rarely repeats itself exactly, but it often rhymes. And with Treasury yields again approaching levels that once seemed ordinary, it’s worth looking back at how investors navigated previous periods of higher interest rates, inflation and borrowing costs.
For nearly four decades since the early ‘80s, investors enjoyed one of the greatest financial tailwinds in modern history. Inflation generally declined, interest rates trended lower, and falling bond yields helped support both stock and bond valuations.
For years, investors became accustomed to falling rates as a kind of financial gravity. When the economy stumbled, the Fed cut. When markets cracked, bonds often rallied. Mortgages got cheaper, refinancing became almost routine and growth stocks benefited from an ever-lower cost of money. After a while, what was historically unusual began to feel perfectly normal.
Then came COVID, massive fiscal stimulus, supply-chain disruptions, trade wars, geopolitical conflicts, oil above $100, enormous federal deficits, and now an artificial intelligence infrastructure boom measured in the trillions, all helping to turn the old investment playbook upside down for diversified investors.
Hello my friend, we meet again
That doesn’t mean 1980s-style inflation is returning or that 5% Treasury yields are permanent. Predicting the next decade of interest rates is about as reliable as predicting the weather in South Florida six months from now.
But investors should at least consider a less comfortable possibility: the ultra-low inflation and ultra-low interest rates of the decade following the financial crisis up till 2019 may have been the anomaly, not today’s environment.
That possibility became harder to ignore this week. Brent crude oil climbed back above $100 per barrel as the conflict with Iran and attacks on Saudi energy infrastructure raised concerns about global supply. The 10-year Treasury briefly approached 5%, while the 30-year reached its highest level in nearly two decades at a similar level. (Source: Reuters, Sept. 11)
Meanwhile, U.S. federal debt has crossed $40 trillion, (source: US Dept. Treasury) Washington continues to borrow heavily, and some of the world’s largest tech companies are tapping capital markets to finance an AI buildout measured in hundreds of billions of dollars.
Oil needs capital. AI needs capital. Washington needs capital.
And capital is no longer free.
Can you take me higher, to a place where blind men see
Hot CPI raises the odds of a September rate hike. While higher energy prices are pushing headline inflation higher, the more important signal may be underneath the surface. The economy remains resilient, while domestically driven inflation continues to grind higher.
Traders quickly increased bets on another Fed rate hike. Markets now price roughly an 85% chance of a quarter-point increase at next week’s meeting, up from about 67% before the CPI report. (Source: Reuters/CME FedWatch, 9.11.26)
Yet stocks initially shrugged. Equity futures remained higher Friday morning as investors digested the possibility that another rate hike may already be largely priced in.
Let’s go there, Let’s make our escape: The 40-Year Tailwind Changed Direction
It is difficult to appreciate just how unusual the past several decades were without looking at an interest-rate chart (see below).
higher interest rates
The 10-year Treasury yield peaked above 15% in 1981 with the 30-year mortgage rates at nearly 17%. Over the following four decades, inflation and interest rates generally marched lower, culminating during the pandemic when the 10-year briefly fell below 1% in 2020.
That enormous decline in rates was like riding a four-decade escalator downward. It wasn’t simply good for borrowers. It became a powerful tailwind for investors.
When interest rates fall, existing bond prices generally rise. Lower rates can also make future corporate earnings more valuable, supporting higher stock valuations. Homeowners refinance. Companies borrow more cheaply. Private equity gets cheaper leverage. Investors become more willing to pay higher prices for growth.
An entire generation of investors grew accustomed to the idea that when trouble arrived, interest rates would eventually come down and bonds could help cushion stock-market declines.
My Own Prison: Bond Headwinds Since 2020
Then inflation returned while intermediate and long duration bond rates increased. And for investors who owned longer-duration bonds expecting them to provide stability, the past five years have been an uncomfortable reminder that bonds can lose substantial value when rates rise. The wind changed direction.
While the traditional 60/40 portfolio has recovered to new highs, the journey over the past five and a half years has been anything but smooth. As the chart illustrates (below), Treasury ETFs representing short-, intermediate- and long-term maturities have produced dramatically different results. SHV has been roughly flat, while IEF and TLT have declined approximately -17% and -55%, respectively, as rising interest rates punished longer-duration bonds.
higher interest rates
The important point isn’t that bonds suddenly “don’t work.” In fact, today’s higher yields mean investors can finally earn meaningful income again. But higher yields come with greater interest-rate risk, particularly for investors reaching further out on the yield curve.
The lesson is different: duration is no longer the automatic shock absorber investors became accustomed to during the great bond bull market. Navigating the bond market through higher rates and inflation may require a bit more creativity, using different maturities, credit sectors and global opportunities to generate income while managing interest-rate and inflation risk.
Inflation Has More Than One Engine
Inflation is another place where the old assumptions are being tested. For much of the past year, investors have debated when inflation would finally glide back toward the Federal Reserve’s 2% target. Instead, inflation has remained sticky, and today’s economy is confronting several forces that could keep it that way.
The first is energy
Oil above $100 is not primarily signaling an overheating U.S. economy. This is largely a supply and geopolitical shock. Middle East hostilities have threatened energy infrastructure and important shipping routes at the same time that gasoline and diesel prices are already squeezing consumers. Diesel recently reached nearly $6 per gallon nationally.
We’ve seen this movie before. Brent crude exceeded $120 after Russia invaded Ukraine in 2022. Oil also spent significant stretches around $100 from 2011 through 2013 amid the Arab Spring, sanctions and instability across the Middle East. Yet expensive oil did not automatically end the economic expansion or stock-market advance.
Supply shocks hurt. They don’t necessarily cause recessions or devastating crashes by themselves.
higher interest rates
The second force is trade
Tariffs and the fragmentation of global supply chains can increase costs even when consumer demand isn’t booming. Canadian retaliatory tariffs of up to 50% on certain U.S. goods took effect this week, while copper reached record highs as tariff concerns collided with constrained mine production.
Copper is particularly interesting because the long-term demand story connects directly to AI. Data centers, electrical grids, cooling systems and power infrastructure require enormous amounts of the metal. Yet global copper mine production actually declined 1.1% during the first half of this year.
Everyone wants to talk about the chips. Somebody still has to build the wires.
The third force is the U.S.debt and capital demand
Federal debt has surpassed $40 trillion, and the Treasury must continually finance deficits and refinance existing debt. At the same time, corporations are borrowing enormous sums for data centers, power generation and AI infrastructure.
That creates another basic supply-and-demand problem. There is an enormous supply of debt competing for investors’ capital.
The Federal Reserve controls overnight interest rates. It does not dictate what investors around the world must accept for lending Washington money for 10 or 30 years. That distinction matters.
Five Percent Isn’t a Crisis
There is another side to this story that gets lost whenever rates jump.
A 5% Treasury yield sounds extraordinary mostly because investors became accustomed to the extraordinarily low rates of the post-financial-crisis era.
Historically, it isn’t. During parts of the late 1990s and 2000s, Treasury yields around 5% were hardly remarkable. Mortgage rates of 6% and 7% were common. Oil eventually moved above $100. Yet the economy continued growing for long stretches and stocks produced substantial gains.
That’s an important distinction because higher rates don’t automatically kill bull markets. The reason rates are rising matters.
If yields rise because economic growth and corporate earnings are strong, stocks can absorb higher borrowing costs. The situation becomes more dangerous when higher rates begin weakening housing, consumer spending, business investment, credit conditions and eventually corporate profits.
We’re watching that balance carefully today. Markets are beginning to feel some pressure. Oil above $100 and the 10-year near 4.84% helped push the major U.S. stock indexes lower for a third consecutive session Wednesday.
But three difficult days don’t make a bear market. Even with all of today’s worries, economic growth and corporate earnings remain relatively resilient. Small-cap stocks, despite their greater sensitivity to borrowing costs and recent weakness, are still up approximately 18% this year. (source: Russell 2000 index)
The economy doesn’t need 2% Treasury yields to function. It may simply need time to remember how to function without them.
A Different Environment Requires a Broader Toolkit
Even if the winds have changed. For investors, this is where the discussion becomes practical. If inflation remains closer to 3% than 2%, energy stays volatile and intermediate- and long-term interest rates remain elevated, the investment playbook may need to be broader than the one that worked exceptionally well during the 2010s.
That doesn’t mean abandoning technology. AI may still prove to be one of the most important productivity revolutions of our lifetime.
But the AI economy is increasingly becoming a physical economy too. It needs electricity, natural gas, copper, cooling, transformers, steel, financing, data centers and industrial equipment. That’s one reason areas such as energy, utilities, materials, industrials and infrastructure deserve attention alongside the companies designing chips and software.
Record copper prices illustrate the point. Copper is up nearly 18% this year as constrained supply meets demand from electrical grids, AI infrastructure, data centers and other capital projects. (Source: WSJ 9.8.26 Copper Scales New Heights)
International diversification may matter more as well. Different countries possess different combinations of energy, natural resources, manufacturing capacity and valuations. Dividend-paying companies and high-quality businesses with strong cash flow may also become more valuable when investors are no longer willing to finance distant promises at almost no cost.
And perhaps nowhere does the new environment require more thought than fixed income.
Retirees and conservative investors don’t necessarily need to make an enormous bet that long-term interest rates will collapse again. Short- and intermediate-term high-quality bonds can now generate meaningful income without taking the same degree of duration risk that punished many bond investors over the past several years.
Treasury Inflation-Protected Securities can provide another tool when inflation remains uncertain.
Ironically, higher rates have made parts of the bond market more attractive, not less. The challenge is deciding where along the yield curve investors are being adequately compensated for the risks they are taking.
Sometimes the best response to a changing environment isn’t predicting exactly what happens next. It’s building a portfolio that doesn’t require one particular outcome.
Six Feet From the Edge
Nobody knows whether today’s higher inflation and interest rates represent a permanent new regime or another chapter that eventually gives way to lower prices and easier money. Our economy is powering forward with trillions of dollars in big tech Cap-Ex spending and the Iran war does not appear to have an end game anytime soon.
We wouldn’t bet a retirement plan on either prediction. But five years after the pandemic, there is enough evidence to consider that something fundamental may have changed.
The investment environment following the financial crisis rewarded falling inflation, declining interest rates, long-duration bonds and increasingly expensive growth stocks. Today’s environment may reward a broader toolkit: income, quality, real assets, energy, infrastructure, industrials, materials, selective international exposure and a more thoughtful approach to fixed-income duration.
Bottom Line: Markets have survived wars, oil shocks, 5% Treasury yields, 6% and 7% mortgages and far higher inflation before. They’ve even prospered during portions of those periods.
Higher rates aren’t necessarily the end of the bull market. The question is whether stocks can keep climbing even as the cost of money moves higher. We think they can, but the path may be bumpier and require a broader investment playbook than the one investors grew comfortable with over the past four decades.
For more information on our firm or to request a complementary investment and retirement check-up with Jon W. Ulin, CFP®, please call us at (561) 210-7887 or email jon.ulin@ulinwealth.com.
Note: Diversification does not ensure a profit or guarantee against loss. You cannot invest directly in an index.
Information provided on tax and estate planning is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
You cannot invest directly in an index. Past performance is no guarantee of future returns. Diversification does not ensure a profit or guarantee against loss. All examples and charts shown are hypothetical used for illustrative purposes only and do not represent any actual investment. The information given herein is taken from sources that are believed to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as NewEdge Advisors, LLC does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors.
