It’s an old cliché, but it may be more relevant than ever: “When America sneezes, Australia catches a cold”. US government bond yields are at their highest in almost two decades, with not-so-quiet whispers that they will go higher. The reasons are high oil prices, a US economy that keeps running hot, heavy government borrowing, and a Federal Reserve that is raising rates again, despite “The Donald’s” verbal pressure on the Federal Reserve Chair. My compatriots in the US tell me reshoring of manufacturing back to the USA is well underway, creating jobs and improving the economy, so the “economy running hot” view is well supported by what I can see and hear on the ground. 

Coolabah Capital’s Christopher Joye has suggested the AI build-out (chips, data centres and the energy to run them) means “for the first time in 40 years, technology prices drive inflation rather than detract from it”. That supports higher yields for longer when you consider the following:

• The US 10-year yield went above 5.1% on 23 September for the first time since 2007. It was about 5.2% by 28 September, roughly 45 basis points higher than a month prior.
• A weak US Treasury auction showed that investors now want more return to hold government debt for longer periods.
• The Fed has raised its target range to 3.75–4.00%, and markets see about a two-in-three chance of another hike in October. Some suggest they will go well past 5.00%. 
• Brent crude is above US$100 a barrel because of conflict in the Middle East.

Australian bond yields have followed US yields up, and the Australian dollar has softened slightly. Joye noted in a recent article that Australia’s 10-year yield has gone from about 1% in 2021 to more than 5%. His other major concerns relate to:

• Australia’s 10-year yield reached about 5.4%, up almost 40 basis points in a month. This will accelerate if the US nears 5.00%.
• All four major banks expect the RBA to lift the cash rate from 4.35% to 4.60% later today. They have pushed back expected rate cuts to around August 2027.
• The Australian dollar fell about 2% over the month to around US70c. That makes imported fuel, components and equipment dearer, although it helps exporters.
• Sydney and Melbourne home prices are reportedly falling at annualised rates of about 17% and 15%. That is a warning sign for manufacturers and distributors of building products, furniture and household goods.

What this means for your business.

Manufacturing was already the weakest part of the economy, unlike in the US. Ai Group’s August data shows it in firm contraction (–16.6) and warns of the impact of further price rises because inflation is not under control.

Distribution is in better shape than manufacturing. It’s still growing; for the June quarter, it grew by 0.5%, but fuel costs are squeezing profits, and stock is building up as borrowing costs rise. Distribution companies feel strongly that inventory is cheap, and “I can’t sell it if I don’t have it”. This ignores the fact that many of those sales might, in fact, be part of your 30% that’s unprofitable. Which is ironic, since the stats show distribution is growing, but they’re earning less on each sale. Profits for the June quarter were down 2.9%. 

In the same article, Joye also warned investors to “avoid illiquidity like the plague” and to stay away from high-yield and private debt. Private credit has officially become one of the fastest-growing sectors of the economy. Depending on whose numbers you use, it ranges between 4% and 15% (<$224 billion) of all commercial funding. It is becoming a meaningful sector of the financial markets to the point that ASIC has stepped up its scrutiny of private credit funds.

Concerningly, private credit defaults have also hit record levels overseas this year. For firms that rely on it, expect higher margins and tougher terms at refinancing. For mid-sized firms, that means lenders, including banks, are likely to become choosier and charge more, just as margins are being squeezed.

As one of Australia’s business leaders, you should be focusing on:

• Working capital. Carrying excess inventory now costs more – it is one of those illiquid assets Joye is warning about. Ask: what cost of holding inventory are we using in our decision-making? My guess is you are not using one, which highlights significant room for improvement in your inventory control. If you do, how far below 20% is it? Many CEOs and CFOs leave that to operational people, but operators are often long-serving employees with a record, a legacy, and an ego to protect, so they often won’t admit they could do better. Take our inventory health check here; it takes a couple of minutes and could save you millions.
• Cost-to-serve. Find the customers, channels and SKUs whose margins disappear once higher fuel, freight and finance costs are counted. Up to 30% of your customers could be eating your margins away because they are simply unprofitable. Strong revenue and revenue growth don’t necessarily mean strong profit growth. Many of our clients find they are significantly more profitable with less revenue. Your customers need to be profitable.
• Funding resilience. Refinance early, spread funding across more than one lender, and stress-test covenants in case rates rise a further 50 basis points.
• Capex timing. Test investment cases against a higher cost of capital, and focus on projects that improve productivity. Don’t wait for government programs to help boost productivity. While we have left-leaning governments now, they will focus on redistribution, not growth. Productivity improvements are yours alone to identify, invest in and implement.
• Demand exposure. If your industry is exposed in any way to the housing sector, weight forecasts for a housing-led slowdown in consumer and construction demand.
• Currency and supplier exposure. Check your FX hedging and the US-dollar pricing in supply contracts.