Large amounts of public sector debt are a cause for concern if there are not enough buyers to finance them, and there are significant consequences of the financing of that debt in relation to the 'crowding out' of other investment opportunities and a rising cost of capital. Higher borrowing costs can be delayed for a time by the maintenance of low short-term interest rates and by the printing of money to buy government bonds, but over the medium term the piper has to be paid.

At the moment it makes sense for banks to attempt to rebuild their balance sheets by borrowing from the government at very low short rates and investing along the government yield curve. This helps governments fund their deficits and, as long as there is no default (mark to market issues aside), the bank gets its money back as well as a healthy amount of interest during the holding period.

While the banks are effectively lending to the government, they are not lending to the rest of the economy, and this is one example of crowding out. Funds that should flow into the economy via the banking system are merely recycled back into funding government deficits. This delays the recovery and keeps inflation low, and it means that investors are content to park their funds in government bonds.

The other issue we face right now is that many governments have reached a critical point, at which further fiscal stimulus would be counter-productive. If the UK was to announce another fiscal package to support domestic demand, the markets would run scared and push gilt yields higher (thereby raising the cost of finance and offsetting any positive effects). Furthermore, the economy becomes immune to further stimulus, the best example being Japan (where the economy failed to respond to repeated government-funded infrastructure projects). We have noticed recently that the normal relationship between government bonds and economic data has started to change. In contrast with the conventional relationship between economic growth and government bonds, stronger economic data could actually become a positive for government bond markets because it reduces levels of debt.

When do the bond vigilantes push yields higher? If we use Greece as a guide, it is when there is a realisation that a country can no longer afford to finance its debt, the usual trigger being a change in short-term interest rates. Last year investors were concerned about debt levels but they were content to fund the Greek deficitwhile interest rates stayed low. The catalyst for market concerns about Greece seems to have been the European Central Bank's decision to start to phase out its 12-month 'repo' funding programmes.

Without the support of ultra low rates, bond markets should be worried by high levels of sovereign borrowing. Big rises in bond yields are likely to occur when the Federal Reserve and the ECB need to raise rates (or perhaps six months before that need arises). We are not there yet, but we are certainly getting closer. In the meantime, there may be positive surprises from revenue increases and also some 'pay-back' from the support governments have provided to banks hitherto. Recent UK data has shown that tax receipts have been higher than expected (perhaps because government forecasters were getting caught up in all the doom and gloom when they made their pessimistic forecasts, or perhaps because some of the increase in government debt will naturally reverse as the economy recovers). The UK will remain in the markets' cross hairs for the next few months as investors digest the next budget, the election and, possibly, another budget and a further election.

With this kind of 'event risk' in the UK, sterling and the gilt market may be volatile places in which to invest, but once these events pass and we are left with a new government charged with addressing the UK's debt-related challenges, sterling could bounce from its over-sold position.

We have identified those countries that will need to tighten fiscally and those that will need to raise interest rates in the map above. Fiscal tightening is good for bond markets, while higher interest rates are generally good for currencies. Given that authorities' policy initiatives around the world are more divergent than they have been for some time, we believe there are some significant opportunities in bond and currency markets.

We have recently added Canadian dollars and Malaysian ringgits to our mix of currencies as they are set to join the monetary tightening club. Meanwhile, our bond positions remain focussed on the grey parts of the map and, where possible, we have taken out some protection in case the bond vigilantes take hold.