I know that I am harping relentlessly on this issue, but it vexes me. Despite signs of recovery in stocks and commodities, short-term interest rates in the U.S. continue to decline. And that's also despite near-record budget deficits, a recent and renewed decline in the value of the dollar and mounting evidence that Europe is recovering more quickly from its sovereign debt crisis that many had projected.

As a consequence, interest rates should be rising back to pre-crisis and pre-correction levels, but they have not. Indeed, since I last focused on the yield on the 2-Year Treasury note, rates have fallen another eight basis points, to just over one half of 1%, while 10-Year Treasury yields remain stubbornly below 3%.

2-Year (Blue) vs. 10-Year (Orange) Note Yields

(Source: The Wall Street Journal)

This makes no sense to me at all. If the conventional wisdom were right, interest rates should be rising as quickly and as steeply as stocks and commodity prices have been rising in the last four weeks.

This is my conundrum. Are rates telling us that growth will slow? Today's personal income and spending data were punk in June, but that's old news. The Personal Consumption Expenditure (PCE) Index, which is the Fed's favorite measure of inflation, declined in June, reinforcing not only the absence of inflationary pressures, but the continued risk of deflation, about which I wrote yesterday.

The deficit hawks, who are screaming that an estimated $1.4 trillion budget deficit in Fiscal 2010 would lead to skyrocketing interest rates and a currency crash, have proved dead wrong. Instead, we are in the midst of a Japanese-style experience where, at least for now, growth is sub-par, debt and deficits are accumulating rapidly, but interest rates are falling, and the dollar is relatively steady, thanks to deflationary influences.

This is not the outcome I had hoped for. It's time to find a way to create a lot more growth and a little inflation. And while the deficit and inflation hawks argue that you cannot get just a little bit pregnant in that regard, I argue that we can, and must.

When I started in this business in 1984, the so-called "bond market vigilantes" moved interest rates substantially higher every time the risk of inflation reared its ugly head.

The same vigilantes are back, but they are sending a warning shot about deflation. We're just not used to hearing the bond market warn us about falling prices. We are only used to worrying about the cost of living going up.

The opposite can be just as bad and that's what the bond market is desperately trying to tell us.