Financial markets are poised for another turbulent week with the risk of further aggressive selling of US and European government bonds, leading analysts believe.

The battering suffered by the US Treasury bond market at the end of last week, when it endured its worst one-day losses for three years, may be followed by fresh turmoil, strategists and economists fear.

Amid mounting pessimism that the US Federal Reserve will cut American interest rates this year, analysts gave warning that the Treasury bond market may succumb to a further sell-off that could push the yield on benchmark, ten-year Treasury notes through the key technical barrier of 5.25 per cent.

Last Thursday the ten-year Treasury yield was driven above 5 per cent by a sudden wave of selling. On Friday it came close to breaching 5.25 per cent, reaching near-five year highs, before a last-minute buying spree saw US bond markets recover some poise.

The two-day rout spilt over into stock markets on both sides of the Atlantic, sending share prices tumbling. Equity strategists fear that any renewed sell-off in the bond markets this week will spark further steep falls in blue-chip shares as investors fret that an era of cheap capital that has helped to finance the present mergers boom may be ending.

Rob Carnell, chief international economist at ING in London, said that last week’s selling of US Treasury bonds came as many bond market bulls, who had been clinging to hopes of Fed rate cuts, finally threw in the towel after a spate of hawkish comments from senior officials at the US central bank.

Mr Carnell and other analysts forecast that this “capitulation” trend was set to continue this week as investors abandoned hopes of any Fed cut and ditched “long” Treasury bond positions built in expectation of lower US rates. Key US inflation figures on Thursday and Friday could also prove to be flashpoints.

“Over the next week, we are likely to see volatility increase as the unwinding of long positions in Treasuries continues,” he said.

Tom Hobson, a senior strategist at Merrill Lynch, agreed. “We are in for a bout of erratic consolidation and volatility. I think there is going to be one more shot on Monday and Tuesday to try to put that ten-year yield above 5.25 per cent.” he said. “There has clearly been a shift of sentiment in fixed incomes and that is jolting equity investors.”

Stuart Block, of Citigroup, argued that there was little chance that this week would see the bond market’s bulls going “back to the races”.

“We are in round two or three [out] of four or five,” he said. “I think it’s going to be quite a tough summer where the market swings around on the data flow.”

Analysts also voiced anxieties that further bond market upheavals triggering rising market interest rates this week could spark a more widespread flight out of risky investments that have been based on a period of cheap money and low volatility. Last week, the Vix index, a key gauge of markets’ volatility, rose for four days in a row, jumping by some 15 per cent.

“It could well be that this proves the unwinding of the very low volatility that we have seen, and that has underpinned a lot of the bets that the markets have on at the moment,” Mr Carnell said.

He cited investments including those based on the yen carry trade, emerging market government bonds, highly priced commodities and high-yielding currencies such as sterling as potentially vulnerable.

Explore Economics

• Pre-Budget Report 2009

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive