The story of the early part of last week was the collapse of U.S. public debt instruments, including, most vividly, the venerable long bond. This has sent their yields flying higher to a level that starts to make them very competitive with high-yield equities. Think about it: the 30-year bond yield rose to 4.6% on Dec. 15, which was up massively from the 3.5% at which it bottomed out the week of the Federal Reserve’s summer retreat in Wyoming.

At this level, it starts to make sense for people that want yield to buy the long bond again. I mean, if you can get 4.6% annually from an instrument that still has, for better or worse, the reputation as the safest financial instrument in the world, you should probably do it — particularly if you are a pension fund manager who can leverage up to make your 8% annual return target.

I realize that widows and orphans were screaming by midweek about the way their bond funds have been ravaged, but my expectation is that the pain should come to an end very soon, if not right away. Just look at the chart above. It shows the price of the U.S. 30-year bond over the past 30 years as it has oscillated within a relatively narrow band. After the wave was established, it has made sense to buy when the $USB is near the bottom of the range and sell when it has been at the top. Right now, it’s very close to the bottom of the range.

For a closer view of the action, here is the Vanguard Long Term Bond Index (BLV) exchange-traded fund, which we owned in the YieldSeeker portfolio earlier in the year, from July to October. It reached an overbought extreme in late August just as the public was being sucked into thinking the world was coming to an end in when equities were down 4% for the month.

And then, perversely, just when bond funds were raking in the new money it began to fall in value: at first a little at a time, and then persistently and urgently. And all that time, equities were rising. Oh, the cruelty. The public — not you, those other people — missed most of the September-October rise in stocks as they were still buying bond funds, as I’ll show you in a moment.

So what about now? If you eyeball the first chart long enough, and think about the fundamentals, you can start to sense that a rebound in the homely long bond is just around the corner, if not sitting right at the curb.

The fundamentals are this: Remember that bonds love misery. Their greatest enemy is inflation, because it makes the value of a dollar in the future worth less than a dollar today. When bond investors come to believe that inflation will crash the party, they sell.

For the past four months, credit investors have been spooked by at least two beliefs: a) that quantitative easing by the Federal Reserve will be highly inflationary due to its increase in the money supply; and b) the Fed’s gambit will work so well that 2011 will be a time of rising employment and an improving economy, both of which imply higher inflation from wages and demand on goods.

So for the bonds to turn around here, as they began to do on Thursday and Friday, a new belief may have to come in from the cold to become consensus: that job growth will continue to be nonexistent next year, and that the economy will continue to underperform despite all the emergency medical assistance being applied by monetary and fiscal authorities. And that therefore inflation will remain as quiet as an old cat sleeping in front of the fireplace.

Personally, I’d love to see the economy roar to life, and I can certainly see that possibility. But I am really challenged to understand where the new jobs are coming from. It’s an old story that industry has shipped off hundreds of thousands of jobs to Asia, and technology has taken the place of hundreds of thousands of jobs that remained.

In my view, there is only one industry that can serve to get Americans working again, and that is home building in combination with commercial real estate construction. It’s the one big industry that cannot be outsourced, it demands a lot of manual labor that cannot be automated, and it can be done by the sort of lightly skilled workers that make up the bulk of the unemployment rolls today.

If I’m right, then the most important data to watch is mortgage applications, new permits, new home prices and new home sales. At the moment, they all range from hopeless to pathetic. But that could change, so keep a close eye on it.

In the meantime, if core inflation remains seriously constrained, expect bonds to recover. I will recommend the long and intermediate bond funds again if they trip my trigger points. Stay tuned.

 (For more ideas like this, check out my daily investment services, Traders’ Advantage and Strategic Advantage).