Here’s a question that perplexes investors and traders alike: why on earth have government bond yields been falling recently even as equity markets have been climbing?

Alas, of the two structural longer term explanations to this question, although one strongly suggests a benign outcome for equities, the other is altogether more malign.

Last week, two-year gilt yields hit their lowest level, which, if you believe the signs of recovery in the UK and stickily high inflation, seems odd. You might have thought that rate expectations and thus short-dated yields would have been a lot higher than they are now.

Now there are, it is worth noting, some specific distortions in the UK. The biggest buyer of government bonds is the country’s central bank and quantitative easing is a lot more aggressive in Britain than elsewhere.

Moreover, the Bank of England’s monetary policy committee is apparently toying with the idea of cutting the interest that it pays on bank deposits to try and get them to lend again, making short-dated government bonds more attractive.

For all the peculiarities of the short end of the UK gilt market, investors have been surprised that longer dated government bond yields have been falling everywhere, even as signs of economic recovery mount. Although there has been a strong consensus that you buy government bond yields only if you are desperate to lose lots of money, of late clearly the opposite has been true.

Now, it could be that the world and his dog were short government bonds or at the very least underweight and have been forced to cover as prices rose. But in this case, the consensus might be right about the longer term direction of government bond yields, only wrong about the timing.

What, though, are the implications if the consensus is wrong? What would it mean if bond yields stay low?

The benign argument for bond yields (and equities) revolves around supply. Many pundits and investors have been in a lather about the vast quantities of debt that governments have to issue. But if an unexpected mountain of supply raises the risk premium that investors demand for holding longer dated paper, the opposite is also true: supply that becomes less Everest-like than feared would reduce it.

So the benign explanation for why bond yields have been falling even as equity markets have been rallying is that worries about the surge in government bond issuance are lessening as signs of recovery mount.

That in turn should lead to a fall in government issuance and thus long-term yields, especially since inflationary pressures (apart perhaps from the UK) are so muted and yield curves so steep by historical standards.

And if that’s right, lower government bond yields would increase the appeal of riskier assets, equities included.

Effectively, the ex ante equity-risk premium would be driven higher because the long-term risk-free rate, but not the growth rate, would be lower.

Sadly, there’s also an altogether more malign explanation. Much as was the case in Japan in the 1990s, it could be that low government bond yields are telling you that this recovery is unsustainable once the monetary and fiscal medicine wears off.

It could be saying that, thanks to the required private sector deleveraging, especially in the US and UK, the long-term potential growth rate of the developed world is much lower than it was. That would lead to a sharply lower ex ante equity risk premium and thus potentially dreadful returns from equities.

This distinction matters as much for coming months as for coming years. Those of a bullish disposition argue that huge operational gearing, the result of all that cost-cutting, will mean that any top-line growth will lead to a surge in corporate profit. Apparently heady current valuations will melt away like snow on the water as these profits come through.

If bond yields have fallen precisely because growth is likely to be more sustainable, that would make sense. But if bond yields have fallen because, as with Japan in the 1990s, bond investors are worried about the sustainability of growth, equity markets themselves look likely to melt.

The writer is head of asset allocation research

at HSBC