The Rise in US Bond Yields

In both the US and Australia, a large number of economists are forecasting that inflation will “behave” and return to lower levels along with interest rates. But in the US the bond markets are telling a totally different story and that story is now really starting to permeate into the share market. 

And so, we see the ten and two-year US bond rates up to levels not seen since around 2006 and 2007 with the ten-year rate at 4.5 per cent and the two-year rate at rate around 2 per cent.

The first reason for the rise in US bond yields is that the markets are watching the actions of the Biden government with its massive spending which is maintaining demand in the US at levels higher than would normally have been expected, given the higher interest rates. 

And to make matters worse President Biden has openly supported the United Auto Workers Union in their wage dispute with two of the largest American car makers. That action will inflame wage claims and therefore inflation around the country.

At the moment US inflation is falling and that trend may continue in the short term, but the bond rates are raising an alert flag for the longer term. In addition, there is a bond demand and supply problem. US banks have been major buyers of bonds and they have lost heavily as the prices of their securities fell in the wake of higher interest rates. 

With sickening losses, they are no longer the same force in the bond market. And of course, the Federal Reserve is no longer buying bonds. Instead, it is letting its securities mature, making it a seller rather than a buyer. And of course, China have their own property crisis and are no longer supporters of the US bond market. 

The US public, nervous of the stock and property markets, have been bond buyers but given the very large sums that need to be raised to fund the spending programs, there is an emerging potential shortage of buyers of US bond securities so the prices fall and yields rise. And of course, the falling bond prices takes the shine off tech stocks because the cost of money is increasing. The same applies to non-growth shares. The NASDAQ market has a higher proportion of technology shares than the wider US stock market so has been hardest hit but the market fall is now widening.

Here in Australia, we can’t afford to let our bond market or our official cash rate get too far out of line with the US or traders will trash our currency and boost inflation. Early signs of a currency crunch have emerged as the dollar fell below 64 US cents this week.

Like the US our inflation is declining but similarly, we have substantial state and federal government spending programs which are boosting wage levels and the federal government industrial relations legislation will reduce productivity.

So, we face two longer-term higher interest rate dangers – the US rate continuing to rise and the continued rise of the cost of business in Australia which can be passed on because of the stimulation to the economy taking place via government spending. These are clear dangers to our share market.

Another danger is the hardening of community attitudes towards business. In the large companies sphere those attitudes are reflected in the ACCC's actions to block Transurban’s purchase of a majority stake in the Eastern Link toll road and the blocking of the ANZ bid for Suncorp Bank. In both cases, the ACCC was trying to promote competition.

Qantas governance

In addition, it rolled its sleeves up and thoroughly investigated the Qantas ticketing policies and alleges that it has discovered that Qantas had been selling tickets on flights that had been cancelled, boosting its profits.

We are also seeing greater activity against large corporates in the taxation sphere and the Victorian and Queensland governments are taking tougher action against landlords. The Greens are pressing for a rent freeze. 

While the above look like isolated occurrences there is an anti-business sentiment rising which is never good for share markets. The decision by a number of leading companies led by BHP, Rio Tinto, ANZ Bank, Commonwealth Bank and Wesfarmers to back the ‘Yes’ campaign with cold hard cash against the will of the majority of the Australian population (as reflected in the opinion polls) will harden anti-business sentiments in Australia. That is going to make it harder for business in Australia. Longer term, there is deep anger in the Liberal Party that large corporations should turn their back on the Liberal Party policies and the views held by the majority of the people. I am not in the business of election forecasting but if the Coalition comes to power either in the next election or the one after then more support will go to smaller enterprises at the expense of larger ones.

I don’t think the chairman of Qantas Richard Goyder understands the depth of the problem facing the company. There are a whole series of governance issues on the table including the fact that Qantas operates without equity capital using fares “paid in advance” as quasi-equity. 

In 2022-23 it spent around $1 billion buying back its shares at prices substantially above the current market. The corporate buyback included buying most of or all of the shares sold by the CEO Alan Joyce at around 6.75. I am a traditionalist and companies that don’t have shareholders’ funds and who buy back shares including shares from their CEO are taking a greater degree of risk than they should, and this is now being reflected in the stock market.

Richard Goyder has been a greater contributor to the companies he has worked for. But he and his board watched the Qantas brand decline dramatically as measured by the Morgan Research polling. Morgan also set out why the brand was declining as it was happening. 

Given Qantas has no shareholder funds the value of the brand is vital to its capital base and the directors did nothing about the fall until the CEO left. In these circumstances, the right thing for the chairman to do is to give notice that in six to nine months’ time, he will step down, but in the meantime, probably with the help of an outsider, he would appoint a new chairman and reconstitute the board. His failure to do this is really impacting Qantas shares along with the cost of repairing the brand and, potentially the heavy damages if the ACCC proves its case. 

Qantas is a great business and can be repaired but simply changing the CEO is only the first step.