You’ve probably seen various stories about the historically high issuance of new debt by the US Treasury this week. There was a small amount of new inflation-protected debt on Monday. That auction went rather well, considering that this isn’t a highly-liquid or widely-owned asset class.

The interesting action was on Tuesday and Wednesday, with massive new issues of 2-year and 5-year notes. Everyone thought those auctions would go very well indeed, following the trend of recent weeks. Instead they were messy and underbid, with low “bid-to-cover” ratios and high “tails” relative to expectations. Participation by foreign central banks appears to have been quite weak.

Today we have an auction of 7-year notes, as well as an announcement that the Fed will go out into the open market to buy up coupon paper in the 7-10 year range. It’s reasonable to suppose that this auction will go well enough, given that everyone’s nerves are on edge and is expecting the worst. A key factor that could easily change the tone will be the weekly initial unemployment-claims data, to be released in about a half-hour as I write.

What’s the underlying dynamic here? Well, part of it is that it’s midsummer and the B-players are manning the trading desks while the A-players are frolicking on the beach. More importantly, a perception is taking hold that economic and financial conditions are improving rapidly. US stock markets took off on a 10% rally almost three weeks ago, just as your ‘umble correspondent was setting out on a blogging drought caused by a string of long business trips. (Hmm. Is there a “Francis indicator”? Does the recent pickup in my own businesses signal a broader turn?)

There’s an important point about how markets work in all this. Markets, like people, respond ahead of time to what they anticipate will happen. If economic conditions in the world are turning up, that means that risk-bearing assets will become more attractive relative to US Treasury debt. It also means that more capital will be deployed in the emerging world, portending a fall in the value of the dollar. And as the stock market rises, it causes debt investors to reach for higher yields.

In sum, conditions appear to be set for the yield curve to flatten, and to rise to a higher level. That will cause some heartburn for the US Treasury, which still has to finance Barack Obama as he burns through our money like a drunken sailor. It’s going to be harder and more expensive for the Treasury to keep up the deficit-spending in the face of increased demand for private capital for other uses.

And that’s interesting because of the potential impact on the government’s macroeconomic policy. We’ve been told by everyone from Paul Krugman to the talking heads on television that economic recovery depends on stimulus spending by the Federal government. Is it really true that stimulus is what’s causing financial conditions to recover? If so, then what happens when interest rates start rising in the middle of the yield curve?

There might be a “gap” between the government’s ability to borrow and spend inexpensively, and the onset of a real economic recovery. We may find ourselves adding huge amounts to the public debt, which will need to be financed expensively, without getting the economic impact Obama promised us.

My own sense is that stimulus is basically a waste of time and money. It has the effect of replacing private leverage with public leverage, so in at a macro level it doesn’t really do anything to improve the financial position of the United States, or (in consequence) our ability to move back to robust economic growth. I still believe we’re at the beginning of a secular low-growth trend.

But back to near-term market conditions. At some point, the market’s expectations of improving business conditions will need to be matched by reality. And as I’ve said all along, there’s very little evidence that consumer demand is picking up. I see businesses beginning to invest in ways that will improve their bottom lines, but not their top lines. Even as profits start coming back, there won’t be much good news on the unemployment front.

Update: Today’s seven-year auction went very well. Indeed, surprisingly well, as the auction yield settled through the market, rather than above it as in this week’s 2 and 5 year auctions. Meanwhile, the stock market is on a wild tear, with the S&P 500 index within spitting distance of 1000.

This morning’s initial-claims report showed a larger-than-expected number of people seeking unemployment compensation for the first time, but overall the report was treated positively. Financial markets are emphatically predicting a strong improvement in the economic outlook.