Continued dip in Treasury yields could benefit MLP stocks

Continued dip in Treasury yields could benefit MLP stocks

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  • Last week, the yield on the ten year U.S. Treasury decreased by 5 bps from 2.04% to 1.99% which is theoretically a positive short-term catalyst for MLP stocks as they are sensitive to rates.
  • Interest rates have been at record lows for roughly the past two years as the Federal Reserve has pumped money into the financial system, and this has been a long-term boon for MLP stocks.

Investors who hold master limited partnership (MLP) stocks often monitor interest rates on Treasury bonds. This is because many investors hold MLP stocks for the distribution, or “yield,” component of the securities. U.S. government Treasury yields are relevant because if rates on the bonds increase, investors should expect rates on MLPs to theoretically increase as well. This is because many view U.S. Treasuries as one of the safest yielding investments in the financial universe, and if the rates on Treasuries increase, the yield required from MLPs (and all other yield instruments) should also theoretically increase. When the yield on MLPs increases, the price and valuation of MLPs decrease.

The yield on the benchmark ten year Treasury moved from 2.04% to 1.99% for the week ending March 15. Five basis points in itself is not a huge movement in Treasuries. However, if yields continued to move downward this could prove positive for MLP names.

In the context of a longer time period, Treasury yields are already close to all-time lows.

Continued dip in Treasury yields could benefit MLP stocks

Only in the past few years has the ten year Treasury has yielded at or below 2%. This is mostly a consequence of the Federal Reserve pumping money and liquidity into the financial system. The below graph shows the yields on the Alerian MLP Index versus ten year Treasury yields.

Continued dip in Treasury yields could benefit MLP stocks

Except for the period of the financial crisis, where investors pulled money out of riskier investments such as equities (which MLPs are) and poured it into cash and Treasuries, MLP yields have often moved directionally the same as Treasury yields.

The movement downward in Treasury yields this past week is theoretically a short-term positive for MLPs. Many market participants believe that rates will not rise significantly in the short to medium term as the Federal Reserve continues to keep rates low given the current shaky nature of the US economy and relatively high unemployment. However, in a longer term context, it has oft been said that “rates only have one direction to go.” If rates eventually rise, for example, to pre-recession levels of 4-5%, it could be a negative for MLPs and the Alerian MLP Index (AMLP). Major names in the index include Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), and Plains All American Pipeline (PAA). Therefore, owners of these securities should be aware of rate movements and how they affect MLPs.

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