Bonds fall on inflation jitters before jobs data

NEW YORK (Reuters) - The U.S. government bond market succumbed to inflation anxiety for a fourth straight session on Thursday with the 30-year bond's yield rising to its highest level in more than nine months.

Compounding the market sell-off was data on jobless claims, retail sales and services activity, which boosted hopes of faster job growth a day prior to the government release of its January payroll figures.

"I think the perception in the market is shifting to worries about inflation from deflation," said Perry Piazza, director on investment strategies at Contango Capital Advisors in San Francisco.

Surging oil and food prices due to civil unrest in Egypt and inclement weather ignited fears the current low-inflation climate will soon end, feeding chatter of the possible demise of a three-decade bull run for U.S. Treasuries.

Fears over a stronger-than-expected jobs report caused traders to ratchet up their expectations that the Federal Reserve would raise short-term interest rates by year-end.

A survey conducted by broker-dealer CRT Capital showed investors were "overwhelmingly bearish" heading into Friday's payroll report with 80 percent of respondents saying the Fed's current super-easy policy is appropriate.

In federal funds trading, the January 2012 futures contract implied that traders expect about a 58 percent chance that the Fed will raise the overnight borrowing cost on excess reserves between banks -- which it controls to manage monetary policy -- after this year's final policy meeting. This compared with a 28 percent implied chance last Friday.

As traders fret over inflation and less accommodative monetary policy, Fed Chairman Ben Bernanke said the economy still needs help from the U.S. central bank despite signs of improvement. While acknowledging the spike in commodity prices, he said domestic inflation remained tame.

But Bernanke's remarks, a pullback in oil prices and the escalated unrest in Egypt were not enough to stem the market decline on Thursday, analysts said.

U.S. benchmark 10-year Treasury note ended down 17/32 in price to yield 3.54 percent, testing the upper end of a 30-basis-point range established in mid-December.

The 30-year bond suffered a larger price drop than the 10-year note, falling 22/32. Its yield finished just below 4.67 percent, the highest since late April 2010.

After falling the previous two days, the cost of five-year credit default swaps on Treasuries debt firmed on very light activity to 47.67 basis points compared with 47.58 basis points at Wednesday's close, according to Markit.

FOCUS ON JOBS

Uneasiness over inflation and how soon the Fed will end near zero rate policy has fueled unusually heavy trading in Treasuries this week. Typically, investors and traders move to sidelines in the week when the government releases its monthly payrolls reading.

Block trades in two- and five-year CBOT Treasury futures totaled more than 33,000 contracts, matching the amount that changed hands on Wednesday.

Tradeweb said Treasury volume was 25 percent above its five-day average and 5 percent above its 30-day average.

This week's upbeat data have raised expectations that the payroll increase could easily beat forecasts and confirm the notion of self-sustaining U.S. economic growth.

"You don't even need a screaming (big) number. It needs one that's close to where the market is expecting," said Mike Ruff, portfolio manager at Russell Investments in Seattle.

The median of forecasts from analysts polled by Reuters is for employers to have added 145,000 jobs in January after adding 103,000 jobs in December. They also predicted the jobless rate likely edged up to 9.5 percent from 9.4 percent.

The U.S. Labor Department will release its January payroll report at 8:30 a.m. EST.