Self-destroying prophecy

Markets: In the natural world, spring is the season of rebirth. This year, the seedlings of renewed economic growth are also sprouting. No wonder investors are getting a touch of spring fever.

The economic winter has been long and unusually cold. It was almost a full year ago that optimists started seeing green shoots of recovery, but until very recently there was little unequivocally good news outside of China.

The blossoms of recovery are finally opening up. In the last week, it was announced that jobs are being created in the United States, temporary employment is up in Germany and economic sentiment in the euro zone is at the highest level since May 2008. There was also a sprig of geopolitical peace, as the United States and China moved away from a confrontation on the value of the yuan.

European investors are the most optimistic they have been since June 2008, according to an index compiled by Sentix. The money seems to be following the more ebullient mood. Credit spreads are down and stocks are up — the MSCI World index has risen 8 per cent since February. Oil, a more speculative asset, has gained 21 per cent.

Some of the money flowing into risky assets is coming out of assets perceived as less risky. The US government has to pay more for its funding — the yield on the 10-year bond has risen from 3.6 per cent to just about 4 per cent since early February. That is still below the average 4.4 per cent over the last decade, but higher yields on what remains the world’s core financial asset could upset the economic recovery — and markets.

The problem is that economic growth is still reliant on artificial monetary and fiscal fertiliser. Government deficits are not going to shrink soon. But higher yields could once again blight the financial system — US mortgage rates are directly linked to treasuries.

The momentum of growth may be strong enough to drag the financial world back to health. But investors could be a little too optimistic for their own good.