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Solar energy stocks had a great day on Tuesday as the market reacted to the potential for lower interest rates in the future.

Stocks were up across the board, but Sunrun (NASDAQ: RUN) led the way, climbing as much as 19.6%; SunPower (NASDAQ: SPWR) jumped 12.9%; Enphase Energy (NASDAQ: ENPH) rose 14.4%, and SolarEdge Technologies (NASDAQ: SEDG) popped 11.4%. The stocks were up 17.7%, 14.2%, 14.1%, and 10.4%, respectively, at 12:30 p.m. ET today.

Inflation, interest rates, and solar energy

The big news was U.S. inflation, which was flat month over month and up 3.2% from a year ago, below Wall Street estimates. Excluding food and energy prices, the core consumer price index was up 0.2% from a month ago and 4% from a year ago.

What investors are speculating on is the impact that lower inflation will have on interest rates. The Federal Reserve has been raising rates for over a year to tame inflation, and it looks like it has been cut to reasonable levels.

Bullish investors are speculating that, at worst, rate increases are over for the time being and, at best, rates will come down in 2024.

Today’s 10-year Treasury yield has already fallen 18 basis points to 4.46%, and that should be a boon for solar energy companies.

Interest rates have a big impact on solar energy

When interest rates rise, it makes the cash flows from a solar project less valuable. So, either up-front installation costs need to come down or the price charged to customers needs to go up for the project to be profitable.

As rates rose over the last year, it put pressure on solar energy installers, and that’s exactly why we saw solar energy stocks get crushed. So, if rates stabilize or even fall, we might see better market conditions for these companies.

The impact won’t be felt evenly, though. Installers like Sunrun and SunPower would be the first to be helped by lower rates, which could allow them to grow their business rather than shrink, as investors fear.

More installations will lead to more demand for solar equipment from companies like Enphase and SolarEdge. They pointed to both slower end-market demand and installers reducing inventory as the reason for their weak results.

As much as today’s news is a good sign, investors need to step back and look at the bigger picture. Interest rates are up sharply from a year ago, and that means fewer solar installations are economically viable. A few basis points aren’t going to suddenly make the industry more profitable, but it could give time for companies to adapt and for price increases on customers to make sense compared to rising utility rates.

This is a good step for solar energy stocks, but rates could reverse course tomorrow, so beware of thinking the worst is over.

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Travis Hoium has positions in SunPower. The Motley Fool has positions in and recommends Enphase Energy. The Motley Fool recommends SolarEdge Technologies. The Motley Fool has a disclosure policy.

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