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XLU: How Interest Rates Affect Utilities

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Utilities versus Treasury yields

The ten-year Treasury yield witnessed a notable drop late last week due to the trade clashes between China and the United States. It closed at 2.80%. However, early in the week, Treasury yields soared to recent highs after the Fed’s rate hike.

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.

Ylds

Higher interest rates are also expected to dent utilities, considering their heavy capital expenditure requirements. Utilities (XLU)(VPU) commonly carry huge amounts of debt on their books. Higher interest rates increase utilities’ debt-servicing costs, which eventually dents their profitability.

Utilities are currently trading at a dividend yield of 4.3%—nearly at a premium of 150 basis points to ten-year Treasury yields.

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