NEW YORK: The U.S. government bond market, which towers above other assets as the only bastion of strong returns this year, could crumble in 2009.

As the Panic of 2008 wreaked havoc with stocks, commodities and corporate bonds, fearful investors flocked to the perceived safety of government securities, powering the long-term U.S. Treasury bond to its best performance in a generation.

The Federal Reserve's signals that it might buy longer U.S. government maturities have added momentum to the epic rally, sending the yield of the benchmark 10-year Treasury note tumbling a huge 1.5 percentage points, to near 2 percent, in just one month. Because bond yields and prices move inversely, these plunges have delivered stellar gains to those holding Treasury securities.

But with the U.S. government expected to issue from $1.5 trillion to $2 trillion of debt into the $5 trillion Treasury market to finance its rescues of the financial system next year, the risk of a sudden drop in prices is growing, analysts warn.

"As an investor in the Treasury market I would be very careful," said Carl Kaufman, portfolio manager for fixed income with Osterweis Capital Management in San Francisco.

Through last Friday, the Barclays Capital U.S. Treasury index was up 14.96 percent year-to-date, a meteoric return compared with the U.S. Standard & Poor's 500-stock index, down about 40 percent, and U.S. investment-grade corporate bonds' loss of about 7.4 percent.

U.S. Treasury securities are heading for their strongest year since 1995, but the market has already priced in a deflationary outlook akin to Japan's "lost decade," most analysts agree.

The total return of the 30-year bond in the year to date is nearly 45 percent, putting the long bond on course for its best year since 1982, according to Barclays Capital. At that time, the Fed started to tame inflation, igniting a huge bond market rally.

Now, the long-term end of the Treasury market has had its best annual rally in more than a quarter century on investors' deep fears of the global credit crisis and an unusually protracted and painful recession raising the risks of deflation. Any signs of a less than dire economic outcome would batter Treasury securities.

"Either we get deflation or not," said Jay Mueller, a senior portfolio manager with Wells Capital Management in Milwaukee. "If we get meaningful deflation, Treasuries will still be the place to be."

Deflation, an environment of broadly falling prices like Japan experienced in the 1990s, exacerbates economic weakness because consumers and companies put off purchases. Kaufman said that this prospect could push U.S. yields down further, even matching the 1.22 percent of the Japanese 10-year government bond.

But, Mueller said, "if we don't get the deflation, that will make current Treasury yields look unrealistic and you will do a lot better" in corporate bonds. Mueller put the odds of the U.S. economy skirting sustained deflation at about 60 percent.

If that near-miss happens, the economy will probably be very weak but not depressed, pushing up the U.S. 10-year yield to about 2.25 percent a year from now, Kaufman says.

On Wednesday, the 10-year note was yielding 2.18 percent, not far above its five-decade yield low of 2.04 percent recorded on Dec. 18.

"From here, I don't think you will get rich on the 10-year," Kaufman said.

If the U.S. economy were to show some feeble signs of recovery during 2009, then the 10-year note yield could rebound to say 3 percent, handing its holders a loss of 4.5 percent in total return, Kaufman added.

If the United States were like 1990s Japan with enough economic weakness and deflation, then nominal government bond yields could stay very low despite hefty issuance, Mueller said. But in Japan, the savings rate is very high compared with a near-zero savings rate in the United States, which could make demand for U.S. government debt weaker and allow Treasury prices to fall more easily, he warned.

"If you have enough weakness and deflation, Japan at least was able to float enough debt with nominal interest rates staying very low," Mueller said. But, "Japan's domestic savings rate was much higher. Could we pull the same trick off?"