(FORTUNE Magazine) – With the Fed starting to put the squeeze on credit, you'd think that bonds would be a disastrous place to invest--and that's just what the Wall Street crowd peddling overpriced stocks wants you to believe. But the truth is that rising rates are already making some bonds increasingly attractive. And the whole tarnished category should get far more alluring (compared with stocks) in the next year or so. The key, as always, is timing: Start buying low-risk bonds right now, but wait until rates rise a lot more before making a sizable move into fixed income.

And, you can be sure, interest rates will continue their steady climb in the near term--for two good reasons. First, it's likely that inflation will rise substantially above the roughly 2.5% the bond market is anticipating. Over the past 50 years, inflation has averaged 4%, and it often ranges even higher in the kind of robust recovery we're now experiencing. Second, huge budget deficits as far as the eye can see could encourage the foreign investors who fund our borrowing to dump U.S. Treasurys. That will force the Fed to raise real rates to keep overseas money pouring in. Those two factors, says Bill Hornbarger, chief fixed-investment strategist for A.G. Edwards in St. Louis, could push rates on the ten-year Treasury up by over one percentage point, to 5.75%, by late 2004. That number isn't terribly shocking. Over the past five decades the rate on the ten-year note has averaged 6.7%.

Long before the Fed's June 30 rate hike, in fact, bond yields were rising sharply. That's because as soon as investors see inflation coming, they drive up yields. (The bond market never waits for the Fed.) Since June 2003, the yield on the ten-year Treasury note has jumped from 3.1% to 4.5%. In this kind of fast-moving rate environment, bonds with long maturities are risky propositions. (Remember: As yields rise, prices fall.) So, yes, it's too early to invest in long-term government bonds. Yet.

But here's where it gets interesting. Rising yields hit ten-to 30-year Treasurys far harder than they do, say, two-and three-year notes. The reason is simple: With longer-term bonds, holders are stuck with a subpar return for many years, so the price drops sharply as rates rise. And that puts short-term bonds in the sweet spot. An ultrasafe three-year Treasury now yields about 3%, for instance. Compare that with a money market paying just 1.25%. "Now you're getting a nice spread over cash on anything from two-year to five-year Treasurys," says Hornbarger. With yields like that, why keep your cash on the sidelines--or risk it in high-P/E stocks?

There's no good reason at all.