The US Treasury bond market has been under pressure. The yield on 10-year bonds rose to 4.805 per cent on Tuesday, the highest since June 2004, before falling. As a result, the inversion of the yield curve, when short rates are higher than long rates, has almost disappeared.

There are a number of potential reasons for the sell-off. One could be the perception that the US economy is strengthening. After a weak fourth quarter in 2005, output growth is expected to be an annualised 5-6 per cent in the first three months of this year. William Poole, St Louis Federal Reserve president said on Monday that the economy has a “great deal of momentum”, leading to expectations that the Fed will keep raising rates.

But this view does not square with widespread expectations that the US economy will weaken in the second half of the year, under the burden of a slowing housing market. Nor does it square with the weaker trend in US profit forecasts.

Another possibility is that the markets have become concerned about inflation, either because commodity price rises will be passed on to consumers or central banks are running too lax monetary policies.

But if inflation is the concern, that does not explain why Monday’s bond sell-off was accompanied by a fall in gold, a traditional inflation hedge. There has been little sign of increasing price pressures in the core inflation measures.

Nor is the “carry trade” the likely explanation. Speculators have been borrowing low-yielding yen to invest in higher-yielding assets or in fast-appreciating markets. They normally cut those positions on days when the yen rises, but the currency fell on Monday.

Perhaps the most likely answer is that US bond markets are driven by those in Japan. Joachim Fels of Morgan Stanley says the sell-off has been driven “by changing expectations about European and Japanese monetary policies, rather than a changing Fed outlook”.

“This supports the idea of globalised bond markets, where foreign investors become major factors in each national market,” he says. In short, higher yields elsewhere have driven investors to demand more from the US market.

philip.coggan@ft.com

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