Utilities ETFs Could be Headed for Declines if U.S. Interest Rates Rise

The Utilities Select Sector SPDR (NYSEArca: XLU) is off by about 1.2% over the past week. That may not sound like much, but with bond markets implying an interest rate hike by the Federal Reserve is almost a sure thing this month, utilities stocks and exchange traded funds could be headed for declines.

Once the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.

No sector is as negatively correlated to rising interest rates as utilities, meaning the longer the Fed resists raising interest rates, the longer high-yielding utilities stocks and ETFs remain compelling destinations for yield-starved investors.

“The sector has been hurt by the rise in long-term interest rates, which accelerated after the election. The rise in long-term interest rates lowers the multiple at which the utilities sector trades, since it is commonly regarded as a bond proxy, and bonds prices typically fall when interest rates rise,” according to a Franklin Templeton note seen on ETF Daily News.