TREASURIES-U.S. bond prices jump as jobs data disappoints
* Below-forecast jobs growth raises doubts on Fed taper
* Market rebound seen short-lived before next week's supply
* Five-year TIPS yield slips back into negative territory
* Futures suggest traders see Fed rate hike later in 2014
NEW YORK, Sept 6 (Reuters) - The U.S. bond market rallied on Friday with benchmark yields falling back below 3 percent as a government report showed disappointing job growth, leaving traders to question whether the Federal Reserve might pare its bond purchases soon.
In addition to U.S. government debt, prices of mortgage-backed securities, Treasury Inflation-Protected Securities and corporate bonds rebounded on the weaker-than-expected payroll readings after Thursday's market rout.
Further improvement in the labor market is seen as pivotal in the Fed's decision to reduce its bond purchases, known as quantitative easing, or QE.
U.S. employers added 169,000 in August, the Labor Department reported, falling short of the 180,000 forecast by economists polled by Reuters. More alarming to some economists were the steep downward revisions to the job gains in June and July.
"The revisions, more importantly than the actual number, were revised down pretty aggressively. I think people are questioning whether tapering occurs or doesn't occur," said Scott Graham, head of U.S. government bond trading at BMO Capital Markets in Chicago.
The moderate job gain last month helped lower the jobless rate to 7.3 percent, the lowest since December 2008, but analysts downplayed the decline and attributed it fewer people looking for work.
Policymakers want to see the unemployment rate closer to 6.5 percent.
Benchmark 10-year Treasury notes last traded up 20/32 in price, after rising 1 point moments after the payroll data. Their yield fell to as low as 2.864 percent before retracing back to 2.914 percent. The 10-year yield touched 3.007 percent overnight, a level not seen since July 2011.
The two-year note yield, most sensitive to changes in perception on the Fed's rate policy, was 0.455 percent, down 6.3 basis points from Thursday's close. It traded above 0.50 percent for the first time since June 2011 on Thursday.
Short-term U.S. interest-rate contracts implied traders pushed bets on the Fed's first rate a bit later into 2014.
Traders now see just a 46 percent chance of a rate hike in September 2014, down from 53 percent before the report, according to CME Group's Fed Watch, which calculates probabilities based on the price of Fed funds futures traded at the Chicago Board of Trade.
While the latest snapshot of the jobs market missed expectations, some argue it is not so poor the Fed will reverse its intent to dial back QE.
"This was a weak report, but it does not change the tapering call because it was not weak enough and there is a lack of corroborating evidence across the broader economic landscape to suggest a new lower jobs trend has emerged," TD Securities global head of rates, currencies and commodity research Eric Green wrote in a research note.
Prior to the release of the payroll report, Chicago Fed President Charles Evans said the central bank can start shrinking its $85 billion monthly bond purchases later this year as the economy improves. He added it will likely need to hold policy rate near zero for another two years.
With $65 billion of coupon-bearing supply scheduled next week, the bond rally inspired by the weak jobs figures could be short-lived, traders and analysts said.
"With long-end Treasury supply next week, accounts will be willing to sell rallies on a weaker set of numbers," said Tom di Galoma, head of fixed-income rates sales at ED&F Man Capital in New York.
The U.S. economy, while continuing to improve, has not shown signs of accelerating. In fact, the surge in mortgage rates this summer due to the spike in bond yields might be slowing the housing recovery, analysts said.
Moreover, possible U.S. military action against Syria for its alleged use of poison gas against civilians has stoked worries about a disruption of Middle East oil exports, propelling oil prices higher and exerting a drag on the global economy, they added.
These factors, together with another possible showdown over the federal debt ceiling between President Barack Obama and Congress, might cause policymakers to refrain from shrinking the Fed's current monthly pace purchases of Treasuries and mortgage-backed securities at its Sept. 17-18 meeting.
MBS yields, which help set mortgage rates along with Treasury yields, fell sharply on Friday. The yield on 30-year MBS backed by loans guaranteed by Fannie Mae fell 22 basis points from Thursday, to 3.78 percent.
Treasury Inflation-Protected Securities also enjoyed a rebound after Thursday's bond selloff lifted the yields on five-year TIPS into positive territory, something which has not occurred since February 2011.
TIPS yields are commonly referred to as "real" yields because they reflect investors' expectations on economic growth and investment returns excluding inflation.
The five-year TIPS yield slipped back into negative territory, last traded at minus 0.095 percent, compared with plus 0.028 percent late on Thursday.