I believe it
Think back. When rumors of the iPhone first started coming out, they were oddly split between (mostly) rumors of a well-made Phone/iPod combi, and (fewer) rumors of a new breed of Smartphone.
Why would Apple release the Smartphone first? Good business. You don't want to release two new products at once, too risky, too much self-competition, too expensive, etc. If you have two products, you release the higher-end one first, because early adopters are willing to pay a premium. Wait for people like me ($600 on opening day for 1.0? Sure!) to buy the iPhone... then, down the road, release the iPhone nano for people who don't want to pay as much.
My predictions on some details:
Size: Just like the iPhone is slightly larger than an iPod, the iPhone nano will be slightly larger than a nano. They can get away with it when combining multiple devices in one, and releasing a 1.0 product.
Form Factor: This will either be a candybar integrating phone and iPod functions, or a smaller widescreen touch screen. I'd say 70% odds its a mini-iPhone, 30% odds its a clever variation on the nano. (Slider, flip, dial-wheel, etc.)
Web: This phone won't have the web. This will reduce power consumption, work better with a smaller screen, cut cost in a big way. Also, it means it doesn't compete with the iPhone-- one is a nice MP3 Phone, the other is a Unique Smartphone. iPhone competes with the Treo, iPhone nano competes with the RAZR2.
Price: Just like the iPhone costs a fraction more than the iPod, the iPhone nano will cost a fraction more than the iPod nano. I am guessing $250 or $300.
Capacity: Just like the iPhone stores less than the iPod, the iPhone nano will store less than the iPod nano. (Again, don't compete with yourself-- differentiate products.) I predict this will come as a single 2 GB or 4 GB model, no choice.
Subsidy: Apple demanded that this phone not be sibsidized because it would cannibalize sales of the upcoming widescreen iPod (and the current iPods in the meantime). The iPhone nano would compete with other phones (Chocolate, Fusiq, RAZR, etc.) that have MP3 players more directly, so a subsidy here would make more sense. $199 with a contract at first wouldn't surprise me.
Functions: Phone (w/Contacts, Favorites, etc.), SMS, Photos, Camera, Calculator, Calendar, Clock, Notes, Settings. (No Notes if it doesn't have the widescreen multi-touch.)
Limited Web Access: One strong possibility is that the web access could be there, but not limited. No browser, just EDGE apps like Google Maps, Weather, and other widgets. If they do this, iChat will appear first on the iPhone nano, then on the regular iPhone soon after.
Colors: This phone will eventually come in colors. Expect to see black at release, then white, then all-silver, then possibly bright colors.