Fears about the euro zone sent benchmark 10-year Treasurys yields to more than three-week lows and helped them break below technical resistance on Wednesday as investors fretted over further bank restructurings and Italy's soft bond auction.
Bonds rallied even as the Treasury sold $35 billion in new five-year notes to solid demand, the second sale of $99 billion in new coupon-bearing debt this week.
Demand for lower risk bonds heading into a long Good Friday weekend and investors tidying balance sheets for quarter's end added to Wednesday's rally.
"Europe is a lingering threat with the fragility of its banking system," said Russ Koesterich, global chief investment strategist at BlackRock in San Francisco.
Italy paid more to borrow over five years than it has since October at an auction on Wednesday as a lack of progress in forming a new government and worries about Cyprus' bailout hurt demand, though the cost of selling new 10-year debt fell.
U.S. Treasurys rallied after the auction, trailing German government bonds, and U.S. debt extended gains after 10-year yields broke below resistance around 1.89 to 1.90 percent, where a number of investors had stop-loss orders to exit short positions.
"It got under 1.90 percent and a bunch of stops got hit," said Ira Jersey, an interest rate strategist at Credit Suisse in New York.
Ten-year Treasurys were last up 17/32 in price to yield 1.85 percent, down from 1.91 percent late on Tuesday.
The notes' yields had traded from 1.90 and 1.97 percent since the beginning of last week when fears about Cyprus came to the fore. The yields have dropped from 2.09 percent on March 8.
"We priced out any of the tail risk from Europe in the first two months of the year and now those tail risks have come back," Jersey said.
The spread between the 10-year yield and 10-year dollar interest-rate swap rate touched 18.25 basis points, its widest level since June. The 10-year swap spread, a gauge of confidence in the global financial system, has nearly doubled since Cyprus' banking troubles erupted more than a week ago.
Weak growth data from France, whose gross domestic product shrank 0.3 percent in the final quarter of 2012, intensified worries about Europe's continued drag on the global economy.
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The safety bid from Europe helped the Treasury sell $35 billion in new five-year notes with a 46 percent bid for the debt coming from indirect bidders, the highest in eleven months. The debt sold at a high yield of 0.76 percent.
The Treasury will sell $29 billion in seven-year notes on Thursday, the final sale of the week.
The U.S. bond market will close at 2 p.m. on Thursday and it will be shut on the Good Friday holiday. Many major European markets will be closed on Friday and Monday.
The Federal Reserve bought $1.59 billion in bonds due between 2039 and 2043 on Wednesday as part of its ongoing purchase program. It will buy between $4.25 billion and $5.25 billion in notes due 2017 on Thursday as part of this quantitative easing.