Utilities versus Treasury yields
As we discussed previously, the ten-year Treasury yield has risen significantly this year and peaked at 2.9% last week. Utility stocks (XLU) (IDU) are seen as bond proxies due to their stable dividend payments. Higher interest rates could make utilities less attractive compared to bonds. So, we generally see investors selling utility stocks and switching to bonds in order to obtain higher yields when rates rise.
US utilities were trading at a dividend yield premium of ~180 basis points–200 basis points to benchmark Treasury yields during mid-2017. However, the premium has fallen to 50 basis points–60 basis points due to a steep rise in yields.
Higher interest rates are also expected to dent utilities given their heavy capital expenditure requirements. Utilities (XLU) (VPU) usually carry large amounts of debt on their books. Higher interest rates increase utilities’ debt-servicing costs, which ultimately hurts their profitability.