Tuesday's report pushed two-year yields back below 2 percent, heading toward their lowest level since early 2004.
The bearish economic figures solidified the argument that the United States may have already fallen into recession, despite a slew of Federal Reserve interest rate cuts and plans in Washington to spend billions to stimulate the economy.
"All signs point to a recession that started in the first quarter of this year. Appropriately, the Treasury market is rallying," said Carl Lantz, U.S. interest rate strategist at Credit Suisse in New York.
The benchmark 10-year note climbed 23/32 in price, which pushed the yield down to 3.56 percent from 3.64 percent late Monday.
The two-year note was 8/32 higher in price for a yield of 1.94 percent from 2.07 percent.
The 30-year bond vaulted more than a full point higher in price, pushing the yield down to 4.31 percent from 4.38.
Early Release Amid Chaos
The bond rally came in a chaotic New York morning session.
Bonds had already been gaining before the release of the services figures, which the ISM published ahead of schedule because of what it said were concerns that the data may inadvertently have been released early.
The service sector represents about 80 percent of U.S. economic activity, including businesses such as banks, airlines, hotels and restaurants.
In the United States, the service sector retrenched to levels not seen since the 2001 recession, renewing fears an economic slump was already well under way. The result was below even the most pessimistic of Wall Street economists polled by Reuters, none of whom predicted a fall below the level of 50 that divides contraction and growth.
The service sector figures add to a bleak picture of the economy, which was also fleshed out by Monday's a Federal Reserve survey showing that banks in the United States tightened lending standards and terms while demand for loans weakened among businesses and households.
Stocks steepened their fall early afternoon, but Treasurys did not initially add substantially to gains from a stepped up safe haven bid.
The Dow Jones industrial average fell 2.3 percent to 12,337 points.
"Despite the big swings we have seen in the equity market, bonds haven't seen a lot of intraday volatility," said Carley Garner, senior analyst with Alaron in Las Vegas.
But Garner added: "Bond traders are watching the stock market even though we've had a two- or three-day break in the correlation (between stock prices and Treasury yields)."
The prospect of more issuance via a $13 billion 10-year Treasury note auction on Wednesday and a $9 billion 30-year auction on Thursday curbed Treasuries' price gains, traders said.
"Overall, at these levels we have not seen the demand we have seen in the past," said Tom Tucci, head Treasurys trader at RBC Capital Markets in New York. "We have 10-year and 30-year supply coming up and demand is now more flight-to-quality than real customer demand," Tucci said.