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Treasury rates increased by 16 bps last week, could hurt MLP names

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Oct. 29 2019, Updated 1:22 p.m. ET

  • Last week, the yield on the ten year U.S. Treasury increased by 16 bps from 1.74% to 1.90%.
  • Despite the week’s increase in yields, 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.
  • Treasury yields matter because MLPs can be rate-sensitive instruments and an increase in Treasury yields could push investors to require more yield out of riskier investments, such as MLPs.

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.

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Additionally, when yields on instruments, such as Treasurys, decrease, it also pushes investors seeking current income into other instruments, such as corporate bonds and MLPs. Therefore, as Treasury yields decrease, yields across the bond sector and higher dividend stocks, such as MLPs, also tend to decrease.

The yield on the benchmark 10-year Treasury moved from 1.74% to 1.90% for the week ending May 10th. Yields had generally compressed since mid-March when the ten year was trading around ~2% to lows of 1.65% until increasing again to current levels of ~1.90%.

In the context of a longer time period, Treasury yields remain close to all-time lows. The below graph shows historic yields on the ten year Treasury from the beginning of 2001 to present.

One can see that only in the past few years the 10-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.

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.

Despite last week’s increase in yields, the sustained low rates on Treasuries have been a long-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 U.S. economy and relatively high unemployment. However, in the 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 MLPs should be aware of rate movements and how they affect MLPs.

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