On 28 September, bond yields pushed higher and pulled American stocks further from their record. Within that move, airlines and other companies with large fuel bills fell hardest. American Airlines dropped 2.5 per cent as crude rose.
Two prices moved in the same direction on the same afternoon, and the combination is what matters.
Rising yields mean borrowing is more expensive, for governments, for companies and for households through mortgages and loans. Rising oil means the physical act of moving anything is more expensive, and feeds through into the price of nearly everything that gets shipped. Each on its own is survivable. Together they close the two standard escape routes from a cost problem at exactly the same time.
The usual response to a cost shock is to finance through it. You borrow against next year, you refinance the facility, you stretch the working capital line, and you buy time for the shock to pass. That works when money is cheap. When the shock itself is what made money expensive, the bridge and the river rise together.
The airline sector shows the mechanism in its purest form because jet fuel sits alongside labour as one of the two largest costs in the business, and carriers hedge only part of it. A sustained move in crude lands almost directly in operating margin. American’s second quarter fuel expense rose 83.3 per cent to 4.88 billion dollars, with higher fares recovering less than half of the increase. The company lowered its full year outlook, with zero profit at the midpoint of the new range, against an earlier range centred on 35 cents a share. It has said it expects around 6 billion dollars of additional jet fuel cost for the year.
The underlying cause is a long way from any airline’s control. The conflict involving the United States and Iran has disrupted the Strait of Hormuz, through which roughly a fifth of the world’s oil normally passes, and the disruption has done more to shape inflation expectations this year than any central bank statement.
Scale it down and the structure is identical. A small business facing a cost spike has three doors. Raise prices, absorb the margin, or borrow and wait. In a normal squeeze at least one door is open. In this one, the price rise meets a customer who is also paying more for petrol and a higher mortgage, the margin absorption meets an energy bill that has already eaten it, and the borrowing meets a rate that has moved against you since the last time you looked.
What remains is the fourth door, which nobody likes because it is slow. Reduce the amount of the expensive thing you need. For an airline that means fleet, routes and load factors. For a small operator it means waste, delivery frequency, opening hours that do not earn their energy cost, and the quiet audit of which items on the menu are being subsidised by the rest.
Airlines are saying publicly that demand remains strong and that they are absorbing rather than passing on the full cost. That is a choice made in the belief that the fuel curve normalises, and American’s management has been explicit that they expect to be profitable once it does.
The bet is not on the business. The bet is on the strait.
