In a span of just three months the great safe-haven trade has violently unwound in favor of risk-taking across stocks, speculative bonds, commodities and currencies. And Treasury bonds, which rallied to their lowest yield levels since the 1950s in December, have posted their worst losses since 1994 the first six months of 2009.

Dumping T-bonds has been a great trade this year for several reasons.

First, the yield on the entire Treasury curve was absurdly low heading into January. The bear market in stocks and other risky assets drove investors en masse into safe-haven trades – mostly Treasury bonds starting in August 2007. Then fiscal spending was unleashed as the government attempts to quash deflation in the economy.

The massive supply of Treasury issuance this year has resulted in a deluge of paper hitting the marketplace and investors are increasingly balking at funding America’s multi-trillion dollar deficits at current rates. The Chinese, by far the largest holders of T-bonds at roughly 37% of total outstanding supply, have been unusually vocal expressing their concerns about monster-sized U.S. borrowing since April. Alarmingly, intermediate and long-term rates are violently reversing since May despite aggressive Federal Reserve T-bond purchases as part of its quantitative easing program. Investors should be nervous.

In short, this is the first bear market for Treasury bonds since 1994 and threatens to kill-off the bull market in Treasury securities since it was first unleashed in 1982 – mainly because of too much supply. The era of falling inflation or disinflation has given way to outright deflation since late 2008 – a boon for Treasury bonds. But now the market is concerned about over-supply and the threat of rising inflation as the United States prints its way out of misery.

These concerns are misplaced – at least for now.

The United States currently sports a savings rate of barely 6% of disposable income. That’s not a lot of firepower to spur new borrowing or domestic consumption – especially following a massive bear market in consumer balance sheets, including real estate, stocks and growing job losses. Twelve months ago, the savings rate was barely positive. It’s premature to believe consumers will draw down their newly fortified savings with a parade of fresh spending. That’s unlikely.

The Japanese, who suffered their own version of the “lost decade” in the 1990s, embarked on deflation in 1990 with a 13% savings rate – considerably higher than America’s current rate. Japanese consumers represent 55% of GDP, whereas American consumers represent 70% of total consumption. It’s highly likely that debt reduction and balance-sheet repair will inhibit this recovery and possibly force a repeat of the Japanese malaise more than 18 years ago. Government can print all the money it needs but it can’t force consumers to borrow, spend or purchase a home.

Next, interest rates at the long end are rising rapidly. This has the potential to chock-off any “green shoots” in the economy as refinancing collapses – delaying a recovery in residential real estate.

With stocks seemingly fully priced and certainly not cheap at current levels, Treasury bonds are once again competing with equities. Stock index dividend yields have markedly compressed since March and speculation is now widespread across the same investments that powered the pre-2007 bull market – emerging markets, commodities, foreign currencies. In a new bull market, leadership typically changes; but not since March.

A five-year T-bond currently yields 2.8% and like all T-bonds are heavily oversold while stocks are overbought. Treasury bonds are also selling below par so an investor can lock-in a small capital gain if they hold that security to maturity.

Inflation will make a comeback. No doubt about it. Obama won’t stop until we have inflation again. Yet the transition from a period of historical credit destruction (deflation) – still underway – to rising inflation is still a few years away. Wage inflation is bordering deflation or negative wage growth, housing prices are still deflating and consumer spending remains lethargic. Combined with the lack of bank credit flowing into the real economy, it’s hard to believe the stock market has truly discounted the worst.

This won’t be your typical post-WW II economic recovery.

I’ve started to nibble at five year Treasury bonds. Rates have ratcheted sharply higher since May and, in my view, the next 12 months will see a re-testing of the March 9 lows as deflation returns as a primary threat to recovery. By that time, this round of fiscal stimulus will have run its course and the market will be begging for another New Deal.