Matt DiLallo, The Motley Fool
5 min read
Fed Chair Kevin Warsh recently rattled investors. His comments at Jackson Hole on Aug. 28 caused the odds of a rate hike to rise. If you’ve owned high-yielding dividend stocks for any length of time, you’re probably getting a little bit nervous because rate hikes tend to negatively impact these investments.
While higher rates are more challenging for some high-yielding dividend stocks, others stand to benefit. Here’s a look at the potential losers and winners if the Fed hikes rates.
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Image source: Official Federal Reserve Photo.
Higher probability of higher rates
Warsh didn’t sugarcoat things at the Jackson Hole meeting at the end of August. While he acknowledged that the inflation rate has slowed a bit, the underlying trends haven’t improved enough. If they don’t start getting meaningfully better, the Fed will need to act.
The market immediately reacted to these comments. Traders of fed fund futures priced in a 60.4% probability that the Fed will deliver a 25-basis-point hike on Sept. 16. That’s up from 56% before Warsh’s comments. Some Fed watchers are already assuming two rate hikes this year, with Deutsche Bank expecting quarter-point raises at both the September and December meetings.
Higher rates are bad news for most high-yield dividend stocks
High-yield dividend stocks tend to fall at the hint of higher rates. That’s because interest rate increases have two real impacts on these investments. Many higher-yielding companies are heavily reliant on debt. Higher rates make it more expensive to borrow money to fund expansion investments (acquisitions and capital projects) and to refinance existing debt as it matures. Additionally, rising interest rates make lower-risk fixed-income investments like bank CDs and government bonds more attractive to income-seeking investors. As a result, the share prices of high-yielding stocks tend to fall, causing their dividend yields to rise to compensate investors for their higher risk profiles.
Real estate investment trusts (REITs) are among the most rate-sensitive investments. REITs borrow heavily to fund acquisitions and development projects, which helps grow their funds from operations and dividends. Higher rates could stunt their growth, making it harder for them to increase their dividends.
