How a December Fed Rate Hike Could Impact MLPs
What is yield spread?
Yield spread represents the difference in yield between a government bond (typically the ten-year Treasury) and the yield of a stock or asset class such as MLPs. Generally, MLP yields move in the same direction as Treasury yields in the long term. MLP yields trade at a spread over Treasuries. Investors expect a premium for the additional risk that comes with MLPs compared to risk-free Treasuries.
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Currently, the Alerian MLP Index (or AMZ) is yielding ~7.5%. The yield on the US ten-year Treasury is ~2.4%. So the AMZ is trading ~500 basis points outside the Treasury yield. The continued fall in energy prices since mid-2014 caused MLP yields to rise independently of the movements in Treasury yields. The Alerian MLP ETF (AMLP) tracks the performance of the AMZ.
How a Fed rate hike could impact MLPs
A Fed rate hike, which could likely happen at the Fed’s next meeting in mid-December, could impact MLPs negatively in two ways. First, it could result in a higher cost of debt due to higher interest rates, impacting their growth plans. Second, it could make returns look unattractive compared to safer Treasury securities, resulting in investors shifting their focus away from MLPs.