Treasurys rallied Friday after the U.S. jobless rate jumped to its highest in more than 3-1/2 years, soothing fears of an imminent interest rate hike by the Federal Reserve.
Crude oil spiked to new records around $139 per barrel, deepening a stock market sell-offand driving flows out of riskier assets into safe-haven Treasurys. However, a sustained acceleration of inflation pressures even in a period of weak economic growth could later prove negative for bonds, analysts warned.
The jobs report "caught bond and stock traders by surprise. It raised new concerns about where this economy is going and that we may end up in a recession, resulting in a massive sell off in stocks and buying in that traditional safe standby, Treasury bonds," said David Dietze, chief investment strategist at Point View Financial Services in Summit, N.J.
The unemployment rate jumped to 5.5 percent in May from April's 5.0 percent, the biggest one-month jump in 22 years.
The benchmark 10-year Treasury note's price climbed 27/32. Its yield, which move inversely with its price, fell to 3.94 percent from 4.04 percent late Thursday.
The surge in the jobless rate, together with a fifth straight month of declines in non-farm payrolls jobs was a stark reminder that the economy is still struggling with the housing slump and the fallout from the credit crunch.
News of escalating tension between Iran and Israel also spurred safe-haven bidding for Treasuries, analysts said.
Israeli Transport Minister Shaul Mofaz told a newspaper that an Israeli attack on Iranian nuclear sites looks "unavoidable."
Two-year Treasury notes gained 6/32 in price for a yield of 2.41 percent, down from 2.51 percent late on Thursday.
"Geopolitical forces, the employment report and this massive jump in oil prices are contributing to the dramatic decline in stock prices," said Walter Gerasimowicz, CEO of wealth management firm Meditron Asset Management in New York.
"We are seeing people continuing to take some comfort in Treasurys during these periods of volatility," he said.
U.S. stocks traded sharply lower late Friday afternoon, with the Dow Jones industrial average down 2.7 percent at 12,264 points.
Tough Spot for Central Banks
While combating slowing growth, central bankers also face the tough task of containing inflationary pressures, especially from oil and food.
On Thursday, European Central Bank President Jean-Claude Trichet spooked bond bulls when he said he would not rule out raising key euro-zone rates next month.
On this side of the Atlantic, Fed officials, including Chairman Ben Bernanke, were less hawkish than Trichet, but they have been talking down expectations of further rate cuts, at least this summer, analysts said.
U.S. interest-rate futures implied traders see low probabilities of any Fed rate moves through September, but they have fully priced in the likelihood of a quarter-percentage-point hike by year-end, in the face of building inflation pressures.
If sustained, those pressures will likely push longer maturity Treasury yields higher, analysts said.
"I expect the yield curve to steepen over time ... on the expectation of future stronger economic growth, but inflationary fears will also prompt the rates to drift higher," said Gerasimowicz.
Yet on Friday, bond investors were so intent on sheltering in Treasurys from falling stock markets and on fears the economy will deteriorate further that even the inflation-sensitive 30-year bond fared well. They long bond was on track for its strongest daily performance since mid-March.
The 30-year bond's price rose 1-9/32 for a yield of 4.65 percent, versus 4.74 percent late on Thursday.
"Certainly from an inflationary standpoint the long end of the yield curve seems to be saying that the impact of crude's rise will be greater in terms of slowing economic growth," said Mark Freeman, senior vice president and portfolio manager with Westwood Holdings Group in Dallas.
Friday's weak job figures reinforced bond investors' view that the Fed would hold the key federal funds rate target at= 2.00 percent after its policy meeting later this month.