Interest Rates Strike Back

Deck: 

The old paradigm—a strong inverse correlation of high interest rates and lower utility valuations—once again takes hold.

Fortnightly Magazine - June 2006
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The recent breakout of the benchmark 10-Year Treasury yield from the recent mid-4 percent yield band to approximately 5 percent (with some market expectation that it may increase further) potentially has important strategic and value implications for the power and utility industry.

Power and utility industry valuations before the 2003 dividend tax cut were highly negatively correlated (approximately 0.69) to the 10-Year Treasury yield, which is generally viewed as a proxy for interest rates.1 This negative correlation between the 10-Year Treasury yield and industry valuations, however, “decoupled” following the 2003 dividend tax cut. The negative correlation inverted to a positive, but nominal, correlation of 0.33 since January 2003, as industry valuations expanded and sustained at historically elevated levels, even as 10-Year Treasury yields increased or remained static (see Figure 1).

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