TREASURIES-Bonds sell off as stocks gain on bailout hopes

*Bonds fall as stocks rise on bailout hopes, Wachovia deal

*Market ignores biggest payrolls drop since March 2003

*Bailout focus overshadows weak jobs report

By John Parry

NEW YORK, Oct 3 (Reuters) - U.S. Treasury debt prices fell on Friday as stocks rallied even after the weakest jobs report since March 2003, on investors' hopes that a U.S. bailout package for the financial system might be passed.

Investors ventured back into equities on expectations the U.S. House of Representatives will pass the bailout plan and news that Wells Fargo (WFC.N) agreed to acquire embattled bank Wachovia Corp WB.N. Flows went to equities from short maturity government securities, pushing the latter's prices lower.

The 2-year Treasury note's price, which moves inversely to its yield, was down 9/32 for a yield of 1.77 percent US2YT=RR, versus 1.62 percent late Thursday.

"The influences in our markets are not solely economics," said David Ader, head of government bond strategy with RBS Greenwich Capital in Greenwich, Connecticut.

He added that if the bailout package passes, then recent Treasury market trades that have pushed down short-dated yields relative to longer maturities could reverse.

The Dow Jones industrial average rose about 2 percent .DJI in late-morning trading.

U.S. government bonds traded choppily in the immediate aftermath of the jobs report, with market participants hesitating to make major directional bets before the fate of the bailout package, was known, analysts said.

U.S. non-farm payroll jobs decreased by 159,000 in September, much more than economists' median forecast of a loss of 100,000 jobs. The jobless rate was steady from the previous month at 6.1 percent due to a decrease in the work force. But economists expected the labor market to continue to deteriorate.

"Credit market stresses are beginning to impact the labor markets. We may be dealing with even weaker job figures later this year or into 2009," said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida.

The benchmark 10-year Treasury note's price fell 25/32 for a yield of 3.72 percent US10YT=RR, versus 3.63 percent late Thursday.

After the employment report, short-term U.S. rate futures fully priced a 50-basis-point Federal Reserve rate cut later this month.

The paralyzed lending markets remain a major risk for the economy that will likely force the Fed to act, analysts said.

"If we get a rate cut in October, it's not because of employment. It will be a response to the money markets," said Christopher Low, chief economist with FTN Financial in New York.

The 30-year Treasury bond fell 21/32 in price for a yield of 4.19 percent US30YT=RR, versus 4.15 percent late Thursday.

(Additional reporting by Richard Leong, Editing by Dan Grebler)