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updated: 7/8/2011 2:03 PM

U.S. 5-year yields fall most in 14 months as job gains shrink

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Bloomberg News

Treasuries gained, pushing five-year yields down the most in more than a year, after the economy added the fewest jobs in nine months and the unemployment rate unexpectedly rose, fueling bets the recovery is losing steam.

Bonds erased losses, extending a weekly rally driven earlier by concern Europe's debt crisis will worsen. Payrolls increased by 18,000 positions in June, versus a forecast in a Bloomberg News survey for a gain of 105,000, Labor Department data showed. President Barack Obama said the U.S. still has "a big hole to fill" in replacing jobs lost in the recession.

"Today's number forces all the bond bears back to the drawing board," said George Goncalves, head of interest-rate strategy at Nomura Holdings Inc., one of 20 primary dealers that trade directly with the Federal Reserve. "This confirms that the data will remain soft and weak."

Five-year note yields tumbled as much as 18 basis points, the biggest intraday drop since May 2010, to 1.54 percent before trading at 1.56 percent at 2:16 p.m. in New York, according to Bloomberg Bond Trader prices. They have fallen 21 basis points, or 0.21 percentage point, for the week, also the most in 14 months. The 1.5 percent security due in June 2016 rose 25/32 today, or $7.81 per $1,000 face amount, to 99 22/32.

The benchmark 10-year note yield dropped 12 basis points to 3.02 percent and reached 3.01 percent, the lowest level since June 28. It has fallen 16 basis points this week, the most since April 15. Two-year yields slid eight basis points to 0.39 percent and touched 0.38 percent, the lowest level since June 27, after rising earlier to a one-week high of 0.49 percent.

Gap narrows

The yield difference between 2- and 10-year notes narrowed for a fourth day, the longest stretch of decreases since the six days ended May 5, to 2.63 percent. Stocks dropped, with the Standard & Poor's 500 Index falling 1 percent.

President Obama said the payrolls report shows "we still have a long way to go and a lot of work to do." He spoke at a televised appearance in the White House Rose Garden.

"Our economy as a whole is just not producing nearly enough jobs." Obama said. "We still have a big hole to fill."

The report may add urgency to talks on July 10, when Obama and eight Republican and Democratic congressional leaders will try again to find a compromise on cutting deficits and raising the government's $14.3 trillion debt ceiling. The Treasury has said its authority to borrow expires Aug. 2.

"There's not much confidence that there's a working plan to get the economy back on track, or confidence that there's progress on the debt ceiling," said Anthony Cronin, a Treasury trader at the primary dealer Societe Generale SA in New York. "The price action is extended because there's real concern that the economy is entering a new phase of the slowdown."

Interest Rate

The Fed has held its target rate for overnight lending between banks at zero to 0.25 percent since December 2008 to support the economy. The central bank completed a $600 billion bond-purchase program in June to stimulate growth and has continued to reinvest maturing bond proceeds into the market.

"It can't be good for Obama; it's going to be very disconcerting to the Fed," said Richard Schlanger, who helps invest $20 billion in fixed-income securities as vice president at Pioneer Investments in Boston. "It's just more of the same, more disappointment on the jobs front."

The unemployment rate rose to 9.2 percent, the highest level this year, Labor Department data showed. Economists in a Bloomberg survey had forecast it would to hold at 9.1 percent.

June's payrolls total followed a revised gain of 25,000 jobs in May that was less than half the advance initially estimated, data showed. Private hiring, which excludes government agencies, rose by 57,000, the weakest since May 2010.

Inflation Expectations

ADP Employer Services said yesterday companies added 157,000 jobs in June, double economists' median forecast.

The difference between yields on five-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt known as the break-even rate, increased before the payrolls report to 2.15 percentage points, the widest since May 19. It shrank after the data to 2.03 percentage points. The gauge has averaged 1.72 percentage points over the past five years.

Bonds earlier pared a decline amid concern Europe's euro- region sovereign-debt crisis may be worsening. Italian 10-year notes slid for a fifth straight day, pushing yields to a nine- year high, as contagion from Greece's fiscal crisis intensified in the region's biggest government-debt market. Spanish, Irish and Greek bonds also fell.

Treasuries lost 0.5 percent over the past month, paring their 2011 gain to 2.4 percent, according to Bank of America Merrill Lynch's Treasury Master index. The S&P 500 gained 4.5 percent over the past 30 days and rose 7.7 percent for the year.

Treasury Auctions

With a month to go before the nation's debt-ceiling deadline, the U.S. has scheduled three note and bond auctions next week.

The Treasury will sell $32 billion of three-year notes on July 12, $21 billion of 10-year debt on the following day and $13 billion of 30-year bonds on July 14. The sizes are unchanged from the last time the U.S. auctioned the securities in June.