Interest rate sensitivity
As we discussed previously, the ten-year Treasury yield has risen significantly this year and peaked at 3.0% last week, its highest level in the last four years. Rising interest rates are a double whammy for utility investors. Higher interest rates could make utilities less attractive compared to bonds. Thus, investors tend to sell utility stocks and switch to bonds in order to obtain higher yields when rates rise.
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.
The Fed has been more aggressive this year regarding rate normalization. It sees room for more than two more rate hikes this year, which might continue to weigh on utility stocks. Broader utilities (IDU) have fallen about 4%, while broader markets are down 5% this year.