From a supply-side perspective, gold at $1000/oz. is clearly indicating rising inflation pressures. So is the rise in most commodity prices, and the weakness of the dollar. All suggest the Fed is oversupplying dollars to the world and that will eventually show up as higher inflation.
Meanwhile, equities are rising, suggesting the economy is recovering.
Why is the bond market so complacent, with 10-year Treasury yields at 3.5%, in the face of these facts?
1) The bond market has never been very smart about inflation, and neither has the Fed. Everyone underestimated inflation throughout most of the 1970s, and everyone overestimated inflation throughout the 1980s and 1990s.
2) All the internals of the bond market are consistent with the view that inflation is not a problem. TIPS spreads today say inflation will be 2-2.5% for the foreseeable future. Short-term rates say the Fed will keep rates at close to zero for a long time. 10-yr yields are very low from an historical perspective, consistent with the economy remaining weak and inflation remaining low.
3) The widespread belief in the Phillips Curve theory of inflation (which says that economic weakness leads to falling prices) explains why the bond market and the Fed are complacent: the economy is perceived to be so weak that inflation is almost impossible.
4) Although stocks are way up and credit spreads are way down, that is not necessarily an indication of a strong economy or a recovery. Credit spreads are still wider today than at the peak of the 2002 credit wipeout. Equity prices have only recovered to levels first seen over 10 years ago, despite the fact that corporate profits (according to the NIPA data) are much higher. So credit spreads and equity prices are consistent with a view that the economy is going to be very weak and a double-dip recession is a real threat. The improvement in spreads and equity prices is due mostly to the fact that the economy appears to have avoided a catastrophic depression/deflation.
5) The 2-10 spread is about as wide as it gets. That shows the bond market is not completely stupid, since lots of Fed tightening is priced in over the next 10 years. But with the Fed insisting that they will keep rates at zero for a very long time, the curve is about as steep as it can get for now.
6) You don't need to rely on Fed purchases of Treasuries and MBS to account for the apparent complacency in the bond market. (In other words, Fed purchases have not kept interest rates artificially low by any meaningful amount.) All of the observations above seem internally consistent. There is no sign of mispricing in the bond market. MBS spreads are perfectly average. Credit spreads are still very wide, suggesting a very weak economy. A very weak economy supports the Phillips Curve belief that inflation is almost impossible, supporting the low level of bond yields.
7) So the Fed is really the key. If the Fed is not concerned about inflation (and they aren't because of the Phillips Curve), then the bond market isn't.
But that doesn't make the bond market right.