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How Utilities Are Likely to Get Impacted by Higher Interest Rates

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Dec. 4 2020, Updated 10:53 a.m. ET

Interest rate and utilities

US utilities have been one of the main beneficiaries of the near-zero interest rate environment for the past ten years. Utilities’ operations are asset-heavy that need significant external funding apart from cash from operations.

However, the expected rise in US interest rates could hamper the profitability of utilities (XLU), given their higher outflows toward debt servicing.

The near-zero interest rate environment has resulted in low debt cost, which has motivated more new debt issuances than new equity issuances. However, the normalization of interest rates by the US Federal Reserve could reverse the scenario again, as debt servicing would become more expensive.

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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