Sentiment on bond markets has turned in recent months. Since the lows at the end of 2008 bond yields have climbed up more than 100 basis points for 10-year US Treasuries and 50 basis points for German bonds. We are almost back to “pre-Lehman levels”. At first sight, this seems to be quite at odds with the real economy and inflation. After all, since the fall of 2008, the world economy has seen the steepest slide in production for decades and inflation has been declining rapidly. So why this strong rise in yields, unexpected by so many forecasters?

So here it is, the turn of the cycle. It is earlier than most expected and - somewhat ironically -, it is occurring at a time when a string of forecasts has been published e.g. by the IMF, the EU Commission, research institutes and the German government that predict no real recovery until the second half of 2010.

The dramatic downturn in the world economy has spawned a host of horrific scenarios. With global orders for electronics, machinery and automobiles plummeting 20 to 50% on a year earlier and evidence of a severe slowdown in world trade, even experienced and hard-nosed people like Paul Volcker are drawing comparisons with the Great Depression of the years 1929 to 1933. Among the variations of the depression scenario under discussion are the collapse of eastern European economies, government defaults of formerly solid states like Austria and the breakup of the eurozone, with all this culminating in the tears of inflation.

The interaction between the weakness of the real economy and the financial crisis is certainly what makes the current economic crisis both special and at the same time threatening. If the economy does not recover it will be very difficult to get banking markets back into full functioning order again. On the other hand, the dislocation of financial markets represents a considerable hurdle to overcoming the economic downturn.