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Why Utilities Have an Inverse Relationship with Interest Rates

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Higher rates dent utilities’ profitability

Due to heavy infrastructure requirements, utilities (XLU) generally carry large amounts of debt on their books. Thus, when interest rates increase, companies’ debt servicing costs also go up. Ultimately, it hampers utilities’ (IDU) profitability.

Utilities generally pay stable dividends, so they are commonly viewed as bond substitutes. So when interest rates are raised, utilities’ yields could become less appealing for investors than bonds. That is why we typically witness investors selling utility stocks and moving to bonds (BND) in search of relatively higher yields when rates are raised.

XLU vs yld

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Historically cheaper debt  

In the last decade or so, due to the near-zero interest rates, there were more debt issuances than equity issuances by utility companies. But now, as the interest rates are gradually getting to normal, this scenario could slowly change as the servicing cost of debt could rise significantly.

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