The outlook for US interest rates has changed sharply, yet the stock market has continued to climb.
As we entered 2026, investors expected the Federal Reserve (Fed) to cut rates. In fact, the chance of a rate rise at last week's meeting was literally priced at 0% for most of the first half of the year.
Five months later, the Fed has just raised rates for the first time in years, and markets anticipate another hike or two from here. That leaves the expected policy rate for next year around one percentage point higher than markets predicted just a few months ago (a big jump).
Period | 16/09/2021– 16/09/2022 | 16/09/2022– 16/09/2023 | 16/09/2023– 16/09/2024 | 16/09/2024– 16/09/2025 | 16/09/2025– 16/09/2026 |
|---|---|---|---|---|---|
S&P 500 return % | -14% | 15% | 27% | 17% | 14% |
However, while that’s been bubbling in the background, the S&P 500 has been remarkably resilient in its march higher.
On the face of it, these two developments sit awkwardly together.
Higher rates raise borrowing costs and improve the returns available from cash and bonds, raising the bar for shares to justify their extra risk. They can also make the future profits of highly valued companies look less attractive today.
The strength of corporate profits helps explain why shares have continued to perform. The US economy has remained firm enough to support earnings, and the artificial intelligence (AI) investment boom is providing an additional, unusually powerful source of growth.
AI spending is supporting profits
This is increasingly an AI-driven earnings market.
The biggest technology groups are spending vast sums on infrastructure to train and operate AI models. Capital is flowing into advanced chips, servers, networking equipment, data centres and the energy systems needed to keep them running. For the companies supplying that buildout, demand has translated into rapid revenue and profit growth.
Commercial adoption is developing alongside the infrastructure boom. AI is beginning to contribute to cloud workloads, software sales and digital advertising, giving some of the biggest technology companies an opportunity to earn revenue from the technology as well as invest in it.
Goldman Sachs Research suggests that businesses benefiting from AI infrastructure investment could generate roughly half of S&P 500 earnings growth in 2026.
But growth is not limited entirely to a few technology giants.
Revenue and profit are expected to rise across all 11 S&P 500 sectors in 2026. That wider support matters. AI remains the main engine, but broader growth is helping other parts of the market contribute as well.
A tougher test from here
So far, rising profits have outweighed the drag from higher rates. That balance could change.
As returns on cash and bonds rise, companies must produce more growth to support their valuations. This is particularly important in parts of the tech sector where high expectations already leave limited room for disappointment.
The next phase of the AI cycle will also bring greater scrutiny. Suppliers of chips and infrastructure are already seeing tangible benefits, but companies pouring money into AI will ultimately need to demonstrate that the investment produces worthwhile returns. New sources of revenue, lower costs, and improved productivity will become increasingly important measures of success.
We don’t see any signs of this, but a weaker earnings outlook would make higher rates much harder for the market to shrug off. Companies would then face greater valuation pressure without the protection offered by rising profits.
Final thoughts
This article isn’t personal advice. If you’re not sure what’s right for you, ask for advice. But the key message for us is that a booming AI investment cycle and a resilient US economy are keeping earnings on an upward path. That has allowed the stock market to withstand a much less supportive rate outlook. But as rates rise, the margin for error narrows.
With this backdrop, we remain constructive on many US companies we provide research on but increasingly prefer those with an investment case supported by strong earnings growth. In turn, we shift to a slightly more cautious stance on names that rely more on earnings multiple expansion as their key catalyst. Investments rise and fall in value, so you could get back less than you invest.
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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Yields are variable and not guaranteed.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment.