Shorting Bonds Will Be 'Trade of the Decade': Kass

Looming inflationary pressures are threatening the enormous rally in the bonds market, hedge fund manager Doug Kass told CNBC.

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"I personally believe that the trade of the decade will be to short bonds," said Kass, general partner in Seabreeze Partners in Palm Beach, Fla. "I know it's a variant (position)."

The Treasury Inflation Protected Securities, or TIPS, market is showing investors believe inflation is on the horizon, a bad sign for fixed income whose value erodes as interest rates drift higher.

"It's interesting to note that the implied inflation rate in the 10-year TIPS has gone from 1.5 percent to 1.92 percent this week. So we're beginning to see inflationary pressures," Kass said. "It's very clear in the gold market, it's clear in the industrial commodities and the CRB," the latter a reference to the Commodity Research Bureau.

While inflation was 1.15 percent in August and was in that range for the entire summer, the CRB's Continuous Commodity Index has seen a steady climb and is in fact about 24 percent higher than it was last year.

Kass said the 10-year Treasury yield is too low now considering inflation expectations. The benchmark note historically has been 3 percentage points above inflation and 3.60 percentage points above real GDP, which was 1.6 percent in the second quarter, Kass said. The 10-year note was yielding 2.55 percent in early Friday trading.

"To me the fund flows into fixed income—$500 billion in the last two years—is eerily reminiscent of the movement into domestic stock equities in '99 and 2000, and we know the outcome" of that, he said, adding that the disparity between the 10-year note and inflation expectations "would mean that the bond market is extremely vulnerable."