The 2022 rate-hiking cycle was a brutal reminder that rising interest rates are bad news for most financial assets. Both global equities and bonds fell sharply — a rare double decline that caught many investors off guard. But the reasons stocks and bonds fall when rates rise are distinct, and understanding both helps you think more clearly about portfolio risk.
Why rising rates hurt bonds (directly and mechanically)
The relationship between interest rates and bond prices is the most direct and mechanical in finance. A bond pays a fixed coupon — say, 3% per year on a £1,000 face value (£30/year). When rates in the market rise to 5%, a newly issued bond would pay £50/year. Your existing bond, paying only £30/year, is now less attractive. For it to compete, its price must fall until the effective yield equals the market rate.
This is not a market inefficiency or a panic — it is pure arithmetic. The longer the bond's maturity, the greater the price fall for any given rate increase, because the fixed coupon payments extend further into the future and each one is discounted more heavily. A 30-year government bond can lose 20-30% of its value in a sharp rate rise; a 2-year bond might lose only 2-3%.
Why rising rates hurt stocks (indirect and delayed)
Stocks are not fixed-income instruments, so the impact of rising rates is less mechanical and takes longer to arrive — but it is equally real. There are two main channels.
First, the discount rate effect: stock valuations are the present value of all future earnings, discounted at a rate linked to interest rates. When rates rise, the discount rate rises, and the same stream of future earnings is worth less today. This hits growth stocks hardest, because they derive a greater proportion of their value from earnings far in the future. A company expected to grow fast for 20 years has very "long duration" earnings — and long duration is the most sensitive to rate changes.
Second, the economic slowdown effect: higher rates slow borrowing, reduce consumer spending, and constrain business investment. Corporate revenues and profits eventually fall as the economy cools, reducing the underlying earnings that stock valuations are built on. This channel takes 12-24 months to feed through fully, which is why stock markets can initially rally when rate hikes begin — the economic pain is still in the future.
Bonds feel the pain of rising rates immediately and mathematically. Stocks feel it later and messily — first in their valuations, then in their earnings. But both are, ultimately, lower when money is expensive than when it is cheap.
Not all stocks are equally affected
Value stocks — companies generating strong earnings today — are less sensitive to rising rates than growth stocks, because their cash flows are not far in the future. Utilities and REITs are bond-like (high dividends, regulated revenues) and tend to fall with bonds. Banks can actually benefit from early rate rises, as higher rates widen the spread between their lending and deposit rates — a key reason financial stocks often outperform early in a rate-rising cycle. Energy and materials companies may also benefit if rate rises are driven by strong economic demand rather than inflation control.
What 2022 taught us
The 2022 rate-hiking cycle was historically extreme — the fastest increase in rates in 40 years. Both global equities and bonds fell simultaneously, which normally does not happen (recessions typically see bond prices rise as rates are cut, providing a counterbalance). The 2022 experience was exceptional precisely because inflation forced rates up aggressively, removing the bond hedge that investors had relied upon for decades.