THE ALTA REPORT.
A compilation of BNY Mellon perspectives derived from seeing approximately 20% of the world’s investable assets. From this vantage point we can decipher the trends shaping today’s markets and deliver unique insights.
GLOBAL MACRO
The Utility of Utilities
Why increased demand from artificial intelligence (AI) and other power-hungry tech applications is making utility stocks more attractive, but possibly a worse hedge.
06.05.24
BNY Mellon clients have purchased U.S. utility stocks this year, while eschewing tech stocks.
By Jonathan Vuocolo
U.S. utility stocks are usually regarded as safe, if unexciting, investments that pay steady dividends. But their reputation as a hedge against growth stocks in portfolios could be changing as their performance is increasingly tied to the higher electricity demands from artificial intelligence (AI) and other technological advancements, according to BNY Mellon’s Head of Market and Insights Bob Savage.
Utilities have gotten off to a very strong start in 2024, with the Utilities Select Sector Index up 11.7% year-to-date. The biggest source of the sector’s recent gains has been electrical utilities, which have a 66% weighting in funds that track the index, eclipsing other industry segments such as multi-utilities and gas utilities. Our clients have been buying U.S. utility stocks steadily all year, BNY Mellon iFlow data show, and eschewing information technology stocks (see chart).
Electric utilities have gotten a boost lately from the growth of data centers, which service AI applications, cryptocurrency mining, streaming services and autonomous driving. The 5,300 U.S. data centers consumed more than 4% of the country’s electricity in 2022, according to the International Energy Agency, which forecasts that they will consume 6% by 2026.
With electric utilities getting a pronounced lift from tech, U.S. utilities seem to be behaving more like growth stocks than bonds at present. This comes at a time when one of the biggest concerns for investment managers is lowering equity concentration risk due to the extraordinary 31% weighting the “Magnificent Seven” stocks currently have in the S&P 500.
“Demand for utilities and growth in the sector is clearly linked to the current phase of the AI boom and as such, utilities may have lost some of their countercyclical quality as a hedge,” Savage says.
Utilities’ medium-term fortunes are also tied to government spending. According to McKinsey & Co., of the $393 billion in new federal funding for clean energy in the U.S. Inflation Reduction Act (IRA), more than $250 billion has been allocated for spending in the energy industry. One of the major beneficiaries of this spending could be large data centers that can qualify for IRA funding and tax credits if they are able increase their energy efficiency to meet new standards under the law.
“A very significant portion of the IRA spending could end up being allocated to data warehouses if they are able to demonstrate that they’ve made themselves sufficiently energy efficient,” Savage says.
Investors looking to utilities as a hedge against the Magnificent Seven tech stocks might want to rethink that approach while utility and AI stories are so intertwined, he notes.
GLOBAL MACRO
Asian Currency Weakness Could Hurt the U.S.
The pain that a strong U.S. dollar has inflicted upon Asian currencies could eventually come back to bite the Treasury market.
05.15.24
By Danielle Robinson
Weakness in the Japanese yen is at risk of becoming infectious, hurting not only neighboring East Asian currencies, but also potentially forcing stimulus out of other Asian central banks that could be funded by sales of U.S. Treasurys, according to BNY Mellon Markets macro strategist Geoff Yu.
Treasury investors have not flinched so far, even as the U.S. dollar’s strength has forced the yen to 34-year lows against the greenback, and the Bank of Japan (BoJ) executed its biggest currency intervention in years this spring, on behalf of the Japanese Ministry of Finance. But they may not always be so sanguine if Japan continues to intervene and other Asian countries follow suit, Yu writes in a May client note. The draining of central bank dollar reserves as they prop up their currencies could ultimately increase selling pressure in the Treasury market, he explains.
Here’s why: foreign central banks often intervene by selling dollars, and if the intervention is large enough, they may sell Treasury reserves to replenish their dollar liquidity buffers. Japan’s late-April and early-May intervention reportedly may have cost the BoJ more than $50 billion, according to estimates by some commentators. Yu warns that if the dollar remains high for months to come – and that’s likely if the Federal Reserve continues to hold off on rate cuts – not only is Japan likely to intervene again, but the potential for intervention in other Asian currencies may rise.
“With the jury still out on the efficacy of Japan’s intervention, it could become viewed as an opening salvo in a new round of intervention by Asian central banks,” Yu writes.
Ironically, the yen’s recent weakening was exacerbated by the BoJ’s landmark decision to drop its eight-year-old negative interest rate policy in March. Investors seemed unimpressed with the token rate increase, and Yu believes it is unlikely the yen will find major support until Japan significantly increases rates. That leaves the BoJ with currency intervention as its only tool. It appears our clients have similar views: BNY Mellon iFlow data show clients are holding long positions in the yen forwards market, suggesting they expect the BoJ will continue intervening until the Ministry of Finance raises rates again.
Yu says another way the Treasury market could be affected is if a strong U.S. dollar constrains emerging market trade surpluses, potentially leaving developing economies with fewer new dollars to buy Treasurys for their reserves.
A temporary decline in foreign central bank buying is unlikely to break the Treasury market, but it is one more worry for investors as the U.S. government’s deficits and debt servicing outlays rise. Foreign central banks are some of the U.S. Treasury’s most routine buyers and their presence helps to keep bond prices in check, according to Yu.
He believes Japan will change its tack and opt for smaller, more frequent interventions to smooth out currency volatility, now that larger interventions don’t appear to be stopping the yen’s slide.
Our vantage point comes from:
Touching
20%
of the world’s investable assets*
Safekeeping
$48.8T
in assets (custody and/or administration) as the world’s largest custodian**
Settling
$13.6T
in U.S. government securities daily***
Servicing
$5.3T
average tri-party collateral management balances***
Processing
$2.5T
of U.S. dollar
payments value***
Managing
$2.0T
assets under management1**
Financing
$4.9T
in lendable securities***
Investing
$309B
for Wealth Management clients2**