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How Higher Interest Rates Hamper Utilities

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Dec. 4 2020, Updated 3:53 p.m. ET

Interest rates and utilities

The expected rise in US interest rates later this year may dent the profitability of utilities, given their higher outflows toward debt servicing. The near-zero interest rate environment, in particular, has resulted in a low cost of debt, which has motivated more new debt issuances than new equity issuances. The chart below shows FirstEnergy’s (FE) stock compared to US interest rates during the past five years.

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However, the normalization of interest rates by the US Federal Reserve could reverse the scenario again, as debt servicing would become costlier.

We should note here that Treasury yields (TLT) become attractive when interest rates rise, making utilities less competitive in terms of yields. For this reason, conservative investors tend to dump utility stocks (XLU) and load up on bonds when rates rise.

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