Stocks Are Up, But So Too Are Interest Rates

May was a strong month for investors, with major indices reaching new all-time highs, even as the bond market faced challenges from inflation concerns. The S&P 500 climbed above 7,500 for the first time, supported by continued strength in technology stocks. At the same time, long-term interest rates rose to nearly two-decade highs before moderating later in the month as oil prices declined. Hopes for a peace deal in Iran also supported markets, although the situation remains uncertain.

The 30-year U.S. Treasury yield reached its highest level in nearly two decades during the month, before settling back below 5%. The 10-year and 2-year yields both rose as well, as expectations that interest rates would stay higher for longer grew. The market now expects the Fed to hike rates once by the middle of 2027 in response to inflation concerns.

This occurred because both the Consumer Price Index and Producer Price Index reports came in above expectations due to energy prices. Rising inflation tends to push interest rates higher, since investors require more compensation if each dollar is worth less. The concern among some economists is that inflation will broaden across all goods if fuel prices stay higher for longer. Oil prices have come down slightly, to around $4.30 per gallon on average across the country, but this is still about $1.50 higher than before the war in Iran.

In spite of higher interest rates and headwinds to the bond market, the stock market continues to reach new all-time highs. The S&P 500 surpassed 7,500 in May for the first time and there have been 22 all-time highs this year through the end of May. While the Magnificent 7 and other large technology stocks have continued to support the market, the rally has also been broader than in some prior years.

New Fed Chair

Kevin Warsh was sworn in as the new Chair of the Federal Reserve in May, succeeding Jerome Powell. Warsh previously served on the Fed’s Board of Governors during the 2008 global financial crisis and is viewed by markets as a known quantity with experience in monetary policy and financial markets.

Fed leadership transitions happen infrequently by design, so they naturally raise questions about the path of policy in the years ahead. Warsh is seen as a reformer, which can raise more uncertainty as to how a Fed under his leadership will conduct monetary policy. In his recent Senate testimony, Warsh emphasized that monetary policy independence is essential and that policymakers must act in the nation’s best interest. He has also signaled a preference for a more focused central bank, with views that have historically leaned toward managing inflation risks.

Regardless, the Fed faces a challenging economic environment. The overall economy is still healthy, but inflation has accelerated in recent months while the labor market has been mixed. Supporting hiring would normally call for lower rates, while addressing inflation would suggest tightening financial conditions. This creates a difficult balancing act, and markets have now flipped from expecting further rate cuts to at least one rate hike. For investors, history shows that the economy has grown across the tenures of many different Fed chairs, regardless of political environment or policy approach. Earnings growth, productivity, demographics, and innovation are ultimately the most important drivers of long-run returns. Changes at the top of the Fed can generate uncertainty, but they rarely alter these long-term fundamentals.

The bottom line? May brought new milestones for the stock market, extending a strong run for investors. While headlines around inflation, the new Fed Chair, and geopolitics will likely continue to generate uncertainty, the best approach for investors is still to focus on their long-term financial goals.

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