The recent sharp rise in US Treasury yields may partly reflect supply pressures and investor worries about longer-term inflationary risks from quantitative easing (QE) but the key driver has been a recovery in economic momentum.

The first chart shows three-month changes in the 10-year Treasury yield and the Institute for Supply Management (ISM) manufacturing new orders index – a good summary measure of economic momentum. A positive correlation is apparent, with the recent yield surge coinciding with the largest three-month rise in the new orders index since 1983.

The relationship suggests that the direction of yields depends not on the rate of economic growth but on whether it is accelerating or decelerating. When the new orders index reached a record low of 23 last December, it was clearly much more likely to rise than fall, implying that Treasuries were high risk. The bearish case is now less clear-cut – even though the ISM index is back above 50, signalling economic expansion.

To assess Treasury market prospects, therefore, it is helpful to have an idea where the new orders index could be heading. The second chart compares the recent revival with an average of five prior recoveries from troughs when the index fell below the 40 level. (The troughs occurred in January 1958, December 1974, June 1980, January 1991 and January 2001.)

The historical pattern suggests that the new orders index could rise further to 55-60 in the short term. Interestingly, however, the average registers a peak in August 2009, treading water over the autumn before a further move up around year-end. If the current cycle follows this template, Treasuries could enjoy a short-term rally later this summer, even in the context of an ongoing economic recovery.