Why are investors turning against US government debt?

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BBC business editor Robert Peston on the outlook of the world's largest economy

The big financial economy and markets event of the past few days has been a sharp fall in the price of US government debt, whose corollary is a rise in the implicit interest rate on that debt, or the yield on US treasuries.

At the beginning of last week, the price of US treasury bonds fell more than at any time since the collapse of Lehman in 2008. By the close on Friday, when prices had recovered a tiny bit, the yield at 3.3% on the bench market 10-year bond was still 39% above the low touched in October.

Now it is important to put this into perspective. The yield on US government bonds is still incredibly low by historical standards - the US government can still borrow remarkably cheaply.

Some investors, largely banks and pension funds, will be nursing a bit of pain from the fall in prices. But the uber bears can't yet claim that this is the beginning of a devastating implosion of a great bubble in US treasuries, which was pumped up by the Federal Reserve's creation of all that cheap money to ward off deep recession.

So what has been going on?

Well there is no little debate about what all this means. And what's particularly unhelpful is that the competing explanations are the difference between economic heaven and hell for most of the rest of us.

The fashionable explanation is that the rise in yields should be seen as good news, because it shows that investors are becoming more confident in the US economic recovery - which is a combination of slightly better data on trade and growth in the US, combined with optimism about the impact of President Obama's decision to extend his predecessor's middle-class tax cut.

On this view, investors are prepared to buy riskier assets - shares for example - and are therefore minded to reduce their relative exposure to those assets perceived to be free of risk, viz the sovereign obligation of the US.

The competing explanation may appear to be based on an almost diametrically opposite view of the prospects for the US. It is that the tax cut shows a US administration utterly incapable of getting to grips with public-sector deficit and debt as unsustainably large as anything the fringe of the eurozone can boast - which proves that the quality of US sovereign debt ain't what it was, so you sell.

On this interpretation, the US economic recovery won't accelerate enough to generate a sufficiently big increase in tax revenues, to make a sizeable dent in an annual deficit running at around $1.5 trillion or well over 10% of GDP.

If you click on Stephanie Flander's blog in the next day or so, you'll find a more detailed analysis of the quality of US government debt.

But the big question is whether what's happening to US treasury bonds shows that those who control the vast pools of money are becoming more or less confident about the outlook for the biggest economy in the world and for growth prospects in general.

It is certainly relevant that there has been a smaller but corresponding fall in the price of German government bonds - which probably stems in part from the fear that the German state balance sheet is being infected by insidious migration on to this balance sheet of the debts of Greece, Ireland, Portugal, Spain, Italy and so on.

On that view, there has been impairment of the quality of all the best western sovereign debt.

The other important development last week was the fairly abundant evidence that the Chinese economy is close to overheating: inflation at more than 5% is high and rising, fixed asset investment is growing at an annual rate of almost 25%, industrial production is increasing at more than 13% per annum, and nominal retails sales growth is almost 19%.

Which rather implies that, whatever their public posture, the Chinese authorities will try to choke off the dangerous part of this boom by allowing a further rise in the yuan and increasing interest rates - although they know, and fear, that to do so would suck in more so-called hot money from the rest of the world (which would tend, I suppose, to reinforce a fall in the price of US and German sovereign debt).

Anyway, when I put all this together I am left with a slight uneasy feeling.

What's clear is that investors are no longer as enamoured as they were with the public-sector debts of the US and Germany.

What is less clear is whether that's a good thing, reflecting the growing confidence of investors that it has become safer to put their money elsewhere, or whether it shows creeping fears about incipient inflation and the recognition that even the world's best credits have been tainted by the leverage virus.‬‪

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.

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