The great Herb Stein, American economist, wit and raconteur, once observed that “if something cannot go on for ever, it will stop”.

I have been thinking about this over the past week as global bond markets have been experiencing what newspapers like to call “turmoil”, or if their readers’ IQs are closer to double digits, “panic”.

For the past five years US Treasury bonds have been yielding what seem, at least by recent historical standards, improbably low rates. The interest rate on the ten-year benchmark bond has stubbornly refused to move much above 5 per cent, even though the US economy has been growing robustly for most of that time. For most of this year, in fact, the yield has been below the overnight lending rate set by the Federal Reserve.

This inverted yield curve was thought by some to presage deflation and then recession – but neither came and yet still the long-term interest rate stayed low.

Then suddenly, beginning about a month ago, long-term rates have shot up. The yield on the benchmark bond has gone from 4.7 per cent to, at one point last week, over 5.3 per cent. As Anatole Kaletsky pointed out in these pages yesterday, this is “probably the single most important number in the global markets”.

Global markets are large and diverse and, as you would expect, there have been a number of explanations for this sudden change of sentiment. A popular one is that Asian central banks – especially China’s – have lost their appetite for US Treasury bonds. They have begun diversifying their currency reserves into euros and sterling, and stopped buying ten-year bonds and that sent the yield soaring.

There is only one thing wrong with this theory – it doesn’t fit any of the other available facts.

For one thing, the US currency has actually been strengthening during this bond market excitement, which seems to suggest it is not the result of a portfolio shift out of US assets. For another, government bond yields have been rising sharply everywhere, as have the rates on corporate debt.

A second explanation is the frightening story about the return of that old zombie from the 1970s – inflation. The sudden realisation that inflation is back has sent holders of highly priced US debt scurrying for the exits.

But this won’t do either. While it is true that the inflation trends in Europe and Asia are upwards, in the US the data have been moving in the opposite direction. Last week we had another significant drop in the consumer price index; US prices are now rising at an annual rate of just over 2 per cent – down from almost 3 per cent at the end of last year.

Other market indicators also suggest that the bond market frenzy has not been an inflation story. Most obviously, the yields on inflation-protected Treasury bonds have not moved at all in the past few weeks, suggesting no change in investors’ expectations of future inflation.

So what is going on?

There are two quite plausible arguments that, between them, seem to me to account for the rise in yields.

The first is that the bond markets have finally come to accept that the US economy is not going to suffer a serious downturn later this year. Market expectations of interest rate cuts by the Federal Reserve have now disappeared and the central bank’s rates are expected to stay flat. That would account for some of the increase in US bond yields.

But the movement in long-term rates was much stronger than could be fully explained by simply this adjustment in expectations about future growth. Something else seems to be going on and that is where the second explanation comes in. As a former senior Federal Reserve official I spoke to this weekend puts it, the answer may be a bigger, longer-term change in investors’ appetite for risk.

The yield on ten-year government bonds reflects both an aggregation of the expected yield on one-year bonds over the ten-year period, and something else; what economists call the term premium. This is the additional interest rate that investors demand simply for the risk of holding long-dated paper on their books. Anything can happen over ten years, and so generally people want a slightly higher rate of return on their assets to compensate them for taking on the risk.

But in the past few years this ten-year term premium has more or less disappeared. Investors seem to have become persuaded that there is virtually no greater risk in holding a financial asset for ten years than there is in holding one overnight.

This reflects in large part what I’ve written about before – the benign effects of the so-called “Great Moderation” in the global economy over the past 20 years. The large fluctuations in output and prices we have seen in the past, which produced all that misery of recessions and inflations, have been dramatically reduced.

You can, however, take this too far. We have reduced volatility, but we surely have not eliminated it, as investors sometimes seem to think. The world economy is undeniably better off than it was 20 years ago, and the patterns of its economic activity are more predictable. But what the bond markets are finally telling us is what we should know: we have not completely abolished risk.

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