On the eve of the G-20 in Toronto this weekend, U.S. financial markets have continued to be dominated by safe haven effects as investors (domestic and foreign) have sought what they consider the safety of Treasury instruments, particularly at the long end of the market. Safe haven effects have been driven by persistent fiscal worries about the eurozone’s ability to manage its fiscal crisis.

But investors are also concerned about the global slowdown: in Europe, because of fiscal tightening; in the United States, because recent economic data (like the new cautionary tone coming out of the Fed earlier in the week) suggests that growth momentum may be slowing and inflation remains very subdued; for China, while its currency appreciation (if sustained) may make global trade more market-based in the longer run, it may dampen growth in the nearer term - at the same time everyone else’s economy is slowing. These global slowdown concerns have accelerated movement out of stocks into the U.S. bond market, as well.

In the run-up to the G-20, Fred Bergsten has a very relevant op-ed in the Financial Times on our continuing economic challenges, which may well become even tougher by the way the global economy is “rebalancing” while the United States just goes along.

And we have also seen a remarkable development: reports have appeared that investors are moving more into Fannie and Freddie [mortgage market] holdings, at a time when the U.S. mortgage market appears to be softening. (And it has still never recovered from the subprime debacle). Explanations are challenging, but perhaps the answer lies with Congress: the financial sector reform bill appears to have been finalized and the difficult challenges of unwinding Fannie and Freddie from the government’s balance sheet have been separated from the bill - and perhaps delayed. Thus, Fannie and Freddie remain as always – backed by the government (this backing became more explicit with the unfolding of the financial crisis).

The increase in demand for U.S. government instruments due to these various effects has resulted in even lower interest rates, particularly at the long end of the market. The yield curve has flattened.