After years of rising and elevated rates, central banks in many of the world’s major economies are beginning to ease monetary policy in the face of declining inflation. September saw the U.S. Federal Reserve cut its key overnight rate by half a percentage point in its first rate cut in four years, while the Bank of Canada lowered its key interest rate to 4.25%, marking its third rate cut since June.¹ ²

The Fed’s decision to begin cutting interest rates has sparked renewed interest in long-term government bonds, with particular attention on the 20-year U.S. Treasury bond. Likewise, for Canadian utilities companies, which rely heavily on borrowing to finance their capital-intensive infrastructure projects, the Bank of Canada’s lower rates will provide a significant tailwind by reducing financing costs and improving margins.

Understanding the relationship between interest rates in the United States and Canada and their impact on bonds and utilities stocks is crucial for investors looking to navigate a low-rate environment. Falling rates can offer strategic opportunities for those focused on long-term returns.

How Interest Rates Affect Treasury Bonds and Utility Companies

At the core of the relationship between interest rates and Treasury bonds is a simple yet powerful principle: bond prices move inversely to interest rates. When the Federal Reserve cuts rates, yields on newly issued bonds fall, making existing bonds with higher rates more attractive. As a result, their prices increase. Conversely, when rates rise, bond prices decline as newer bonds offer more attractive yields.³

Interest rates also play an important role for utility companies, which are highly capital-intensive businesses. Whether building out new power grids, upgrading aging facilities, or expanding into renewable energy, these projects often require substantial upfront investment. As a result, utilities is amongst the most debt-heavy sectors in the market, making them particularly sensitive to changes in interest rates. When interest rates fall, the consequent reduction in financing costs directly boosts profitability for utility companies by lowering their interest payments on outstanding debt. It also frees up capital for reinvestment or to strengthen balance sheets, adding to their financial stability.⁴

Impact of Interest Rate Cuts on 20-Year Treasury Bond

When the Federal Reserve cuts interest rates, the immediate impact on 20-year U.S. Treasury bonds is a surge in demand, driving their price higher. Given their relatively long maturity, these bonds are particularly sensitive to fluctuating interest rates. Even modest rate cuts can significantly boost the price of these bonds, offering a window of opportunity for investors seeking capital gains.

For existing holders of 20-year U.S. Treasury bonds, falling interest rates present an immediate benefit. As the value of their holdings rises, they see capital appreciation that enhances the overall return on these fixed-income assets.⁵

However, for new investors entering the market, the landscape is more complex. The compressed yields following rate cuts may make 20-year Treasuries less attractive in terms of income generation compared to existing holders. But 20-year Treasuries still remain a safer and more stable option compared to riskier assets like equities or corporate bonds. Understanding the interplay between bond prices and rate expectations is essential for both capital preservation and growth amidst shifting interest rates.⁶

Impact of Rate Cuts on Utilities Stocks

Utilities are uniquely sensitive to interest rate changes due to their debt-heavy balance sheets and stable, dividend-focused business models. As the cost of borrowing declines, the impact on utilities stocks is immediate and pronounced. These companies, known for their reliable cash flows and strong dividend yields, become even more appealing when interest rates fall, as they offer a level of stability that is hard to find elsewhere.⁷

As borrowing becomes cheaper, the lower financing costs not only boost profitability but also enhance the ability of utility companies to maintain or even increase their dividend payouts. For income-focused investors, this is a critical advantage. As debt becomes cheaper, utilities can allocate more capital toward dividends, reinforcing their role as a key component of any income-seeking portfolio. High-dividend-paying utility companies, like Enbridge and TC Energy, for example, are expected to perform better as rates fall. In this context, rate cuts by the Bank of Canada provide a significant tailwind, making utility stocks an increasingly attractive option for both conservative and yield-focused investors.⁸

With the Bank of Canada signaling ongoing easing of monetary policy over the next year, utilities are likely to remain a preferred choice for conservative investors seeking stability and reliable income. The combination of lower borrowing costs and a continued focus on essential services positions this sector favourably in an environment where interest rates are expected to stay low for the foreseeable future.⁹

ETF Options for Bonds and Utilities

If you’re looking for an opportunity to diversify your portfolio with fixed-income holdings like bonds, one option is investing in fixed-income ETFs.

Evolve Enhanced Yield Bond Fund (BOND ETF) provides investors with a low-cost fixed income solution that seeks to deliver attractive monthly income and long-term capital appreciation. To enhance yield, as well as mitigate risk and reduce volatility, BOND will initially employ an active covered call option writing program on 50% of the portfolio.

For more information on Evolve Enhanced Yield Bond Fund (BOND ETF), explore fund details here.

Or perhaps you’re looking for investments with low volatility and stable revenue? Interested in higher yield from Canadian utilities?

The Evolve Canadian Utilities Enhanced Yield Index Fund (UTES ETF) looks beyond traditional utilities investing to give investors exposure to three kinds of essential services—utilities, pipelines, and telecom. With UTES, you get simplified access to the top 10 Canadian utility, telecom, and pipeline companies in one accessible investment vehicle.

For more information on Evolve Canadian Utilities Enhanced Yield Index Fund (UTES ETF), explore fund details here.

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Sources

1. Cox, J., “Fed slashes interest rates by a half point, an aggressive start to its first easing campaign in four years,” CNBC, September 18, 2024; https://www.cnbc.com/2024/09/18/fed-cuts-rates-september-2024-.html
2. Jones, A.M., “Bank of Canada cuts key interest rate to 4.25%, citing cooling inflation,” CBC News, September 4, 2024; https://www.cbc.ca/news/business/bank-interest-rate-1.7312774
3. “Interest Rate Risk — When Interest Rates Go Up, Prices Of Fixed-Rate Bonds Fall,” U.S. Securities and Exchange Commission Office of Investor Education and Advocacy, May 31, 2013; https://www.sec.gov/files/ib_interestraterisk.pdf
4. Maverick, J.B., “How Interest Rates Affect Utility Stocks,” Investopedia, May 11, 2024; https://www.investopedia.com/ask/answers/070715/what-extent-are-utility-stocks-affected-changes-interest-rates.asp
5. Harper, D.R., “Understanding Treasury Yields and Interest Rates,” Investopedia, March 18, 2024; https://www.investopedia.com/articles/03/122203.asp
6. “Yield Compression: The Effects of Yield Compression on Current Yield,” FasterCapital, June 9, 2024; https://fastercapital.com/content/Yield-Compression–The-Effects-of-Yield-Compression-on-Current-Yield.html
7. Maverick, J.B., “How Interest Rates Affect Utility Stocks,” Investopedia, May 11, 2024; https://www.investopedia.com/ask/answers/070715/what-extent-are-utility-stocks-affected-changes-interest-rates.asp
8. Smith, F., “Canadian investors eye utilities, real estate stocks as BoC cuts rates,” Reuters, June 12, 2024; https://www.reuters.com/markets/rates-bonds/canadian-investors-eye-utilities-real-estate-stocks-boc-cuts-rates-2024-06-12/
9. Suhanic, G., “Posthaste: Bank of Canada can go bigger on rate cuts as Fed ‘blows the door wide open’,” Financial Post, September 20, 2024; https://financialpost.com/news/bank-of-canada-go-bigger-interest-rate-cuts

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