So are bonds a “Sell” and the dollar a “Buy?”

Judging by historical recoveries after a deep recession, the economy has tended to recover quite forcefully. This was the case in 1992-93 and in 1983-84. Investors are starting to wager that 2010 will result in a big year for GDP and along with that forecast a higher dollar and higher rates.

The market has started to discount a high possibility of a Fed rate hike in June 2010 and traders are dumping Treasury bonds in anticipation of this move. And the dollar is responding. Traders point to the steeping yield-curve or the difference between 2-year and 10-year Treasury bond yields – now at its highest spread in years. Historically, a large spread has resulted in good returns for stock investors.

To be clear; the market, not the Fed, is taking interest rates higher. If it continues, the Fed will be forced to act and raise the Federal Funds rate. Yet I think we’re seeing a replay of the April to July price action in Treasury bonds earlier this year, which ultimately resulted in a rally for bonds.

The great post-1981 bond bull market is not far from the cliff.

We are certainly closer to the edge than at any period since 1980. But I’m still wagering that bond yields will witness another rally over the next several months as a severe global correction unfolds in risk-based assets causing a growth panic and taking government bond yields down sharply as fears of a double-dip recession begin to surface by the second half of 2010.

Until then, T-bond yields above 4% or even 4.5% over the next few months look attractive in an environment of renewed “bubbles,” which might get pricked if long-term rates run too far to the upside