Stagflation signs: Bond yields down. Gold up

The yield on the 10-year U.S. Treasury hit a new record low Thursday and was briefly below 2%. The previous low was during the 2008 financial crisis. Click chart for more on bonds.

NEW YORK (CNNMoney) -- Is that a disco ball I see?

Stocks plunged Thursday after several economic reports in the United States raised more worries about stagnant growth and higher inflation.

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I wish there was a word to describe such a scenario. Oh yeah. There is! Stagflation. Remember that old chestnut from the 1970s? Gas lines and what not? Good times. Or not.

Weekly initial jobless claims rose again and were back above 400,000. There's the "stag." And the Consumer Price Index rose at a much higher than expected rate in July. That follows a similarly strong Producer Price Index number Wednesday. Ladies and gentlemen, there's your "flation."

What are investors worried more about? If you look beyond the latest carnage in stocks Thursday, investors are clearly sending a signal that they are worried both about stagnation and inflation. But the emphasis seems to be more on the "stag."

The yield on the 10-year U.S. Treasury note hit a record low Thursday morning, dipping briefly below 2% before bouncing back a bit. Low bond yields are a tell-tale sign of economic malaise. Stop me if you've heard this before, but bond prices and yields move in opposite directions.

And investors often rush to buy Treasury bonds when they are afraid of putting money in riskier assets like stocks. That's still the case even in this brave new AA+ world we live in.

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A report from Morgan Stanley Thursday also helped usher in another new flight to bonds. The investment banks said the U.S. is "dangerously close" to another recession.

As if this wasn't bad enough, there were two other gloomy economic reports later Thursday morning. Existing home sales fell 3.5% in July and manufacturing activity in the Mid-Atlantic region actually contracted in August.

So much for the economic malaise being a "transitory" byproduct of the Japan earthquake in March, huh?

"This is more than just market turmoil. The market is reflecting the uncertainty in the economy," said Reena Aggarwal, professor of finance and business administration at Georgetown University's McDonough School of Business in Washington.

"People see their net worth going down and get concerned about their jobs and 401(k) plans. We can't rely on consumer spending to lift us out of this funk," she added.

Can rates go any lower? Japan, after all, has a 10-year bond yield hovering around 1%. And more and more experts are worrying that the U.S. is now in the midst of a so-called "Lost Decade" of economic malaise just like Japan.

Still, it's probably a stretch to think that the U.S. economy will deteriorate that dramatically to justify rates falling that much.

"Are we Japan? There's no case right now for rates to get that low," said Leslie Barbi, head of fixed income for RS Investments in New York.

Barbi did not rule out that rates could drop further in the short-term, but she said they may finally be getting close to bottoming out. Many investors may grow tired of owning Treasuries with yields this low, she said.

Keep track of gold and other commodities

But investors weren't ignoring inflation worries either. Gold is often viewed as a hedge against inflation. Unlike paper currencies, it's a tangible asset with "real" value.

And guess what? Gold prices shot up to a new record high. In midday trading Thursday, the yellow metal was up more than $25, or 1.5%, to about $1,820 an ounce.

Investors can't dismiss the inflation threat, especially since the Federal Reserve has pledged to keep short-term rates "exceptionally low" until mid-2013.

"Interest rates are very low now but at some point you have to get concerned about future inflation," Aggarwal warned.

The sharp rise in consumer prices -- which can partly be blamed on Fed policies that have fostered an environment conducive to a weak dollar and commodity boom -- is worrisome.

Even if it's not technically the kind of inflation you learn about in economic textbooks (you usually need a strong job market and wage growth for that) it may just be an issue of semantics for consumers.

If you are paying more for things like gas, milk and clothing, then who cares if the so-called core CPI, which strips out volatile costs of energy and food, didn't rise as much as the overall CPI? It's always been a silly argument to ignore them. There's no inflation as long as you don't have a life?

"This isn't yet like the inflation from the 1970s. But it is above average," Barbi said.

With all that in mind -- plus continued fears about the debt situation (not to be confused with Abercrombie & Fitch's least favorite customer) in Europe -- it's no wonder that investors are nervous.

These problems aren't going to be solved overnight. And as long as we have a sluggish economy and higher consumer prices, the threat of stagflation remains very real. Or as I've been calling it for more than a year now, this is the "low and slow" BBQ recovery.

"The market and economy is going to chug along like this for quite a while," Aggarwal said.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.