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Treasurys extend gains after poor 7-year note sale

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Bonds held onto earlier gains Thursday after the U.S. government's $29 billion auction of seven-year notes saw weak demand.

The Treasury Department auctioned the notes at a high yield of 2.235 percent, up from August's 2.045 percent yield, but the bid-to-cover ratio—an indicator of demand—was 2.48, the lowest since June and below the maturity's recent average of 2.56.

Direct bidders took 10 percent, which was their smallest share since July 2012, and dealers were awarded 48 percent, the lowest since June.

Seven-year notes rose 12/32 in price to yield 2.20 percent after the announcement.

Benchmark 10-year notes gained 16/32 in price to yield 2.51 percent, down from a close of 2.57 percent on Wednesday, but still higher than Tuesday's close of 2.53 percent.

On the long end of the yield curve, 30-year bonds gained 1 5/32 in price, bringing the yield down to 3.22 percent.

U.S. government bonds rallied earlier after reports showed the pace of growth in the U.S. services sector slowed in September and durable goods orders came in softer than expected.

"We see the U.S. economy as positive, but not showing the pace of growth that was anticipated,'' said Ellis Phifer, market strategist at Raymond James in Memphis, Tennessee.

The flash services sector Purchasing Managers Index compiled by information services company Markit slipped to 58.5 in September from 59.5 in August, declining for a third straight month. A Reuters poll forecast the September reading at 59.0.

Separately, durable goods orders—items that are meant to last three years or more—declined by 18.2 percent in August, the largest drop since the series started in 1992. Also, initial claims for state unemployment benefits rose 12,000 to 293,000 for the week ended Sept. 20, below the 300,000 forecast.

Benchmark U.S. stock indexes fell to multi-week lows and the CBOE Volatility Index—a gauge of fear in the market—rose to 15.92, its highest level since August 8.

"It is unacceptable for an economy the size of the U.S. to have this sort of volatility,'' said George Goncalves, head of rates strategy for Nomura Securities in New York. ``Whenever you get these blips in the radar, it looks out of form.''

Reuters contributed to this report.