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Updated from 11:00 a.m. EDT

Treasuries were hammered Thursday by the threat of a strong monthly payrolls report and evidence that liquidity around the world is set to tighten.

The benchmark 10-year note fell 12/32 to yield 4.89%, the highest level since June 2002, while the 30-year bond sank 28/32 to yield 4.96%. Bond prices and yields move in opposite directions.

The two-year note edged lower 2/32 to yield 4.83%, and the five-year note lost 6/32 to also yield 4.83%.

Nearly two weeks of declines have built a risk premium back into the long end, in the form of higher yields, and widened the spread between the 10-year and two-year yields to six basis points. Longer-maturity debt usually yields more than shorter-maturity debt to compensate investors for lending money for a longer period of time.

However, the curve has been flat or even inverted since the beginning of the year, a phenomenon Alan Greenspan called a "conundrum" and one that often precedes recession.

"I wouldn't say that the conundrum has significantly ended yet," says John Shin, senior economist at Lehman Brothers. "A lot of

the slide on the long end is in anticipation of tomorrow's jobs report."

Along with the housing market, the employment picture is seen as the key to when the "data-dependent"

Federal Reserve

will stop raising interest rates. Fed funds futures have priced in 100% odds that the Fed will raise rates by 25 basis points in May, taking the rate to 5.0%. But there are only 34% odds for a hike at the June meeting.

Central bankers have voiced concerns that "wage inflation" could occur if unemployment drops and salaries increase enough to ramp up consumer spending.

The March nonfarm payroll report is expected to hold steady at 190,000 and the unemployment rate is expected to edge lower to 4.7% from 4.8%.

The run-up to the March employment numbers has seen a mixed bag of data. Weekly jobless claims through most of March edged higher, the employment portion of the ISM index has fallen, there have been fewer recorded layoff announcements, and an uptick in Internet-based recruiting and hiring.

Most recently, the Labor Department said Thursday that initial claims for unemployment benefits for the week ended April 1 fell by 5,000 to 299,000, vs. expectations for the number to edge higher to 305,000 from 302,000.

This is the first time in six weeks that the number has come in below 300,000, and the four-week average of claims fell to a five-year low.

The upbeat reading had market watchers worried that a robust labor picture could force the Fed to keep raising rates.

"The improvement in the claims numbers is what's really driving our market today," says Steve Ricchiuto, chief U.S. economist with ABN Amro. "People are afraid that the

payrolls number could be in the 250,000 range."

Shin says that the whisper number for Friday's payroll number is higher than estimates, particularly in light of Wednesday's comments from Treasury Secretary John Snow that the report would be strong.

"I don't think the number would have to come in drastically low for yields to reverse," says Shin. "I think expectations for the payroll number have been increased, and if the reading is not in the 200,000 range, people will be disappointed."

Adding to the bearish sentiment for bonds, the Monster Employment Index rose by 4.5% in March. This index measures online advertising and recruitment.

Whether or not the payroll number surprises to the upside, Ricchiuto believes that the average over the next few months will be a healthy 175,000 to 180,000. He adds that the payroll and employment numbers are not the only things weighing on the long end.

"The dramatic moves have really only been in the 30-year ... because we haven't had supply at the long end of the curve for a long time," he says. "We're coming back into supply and we'll see an overall adjustment on the long end of the curve to more realistic levels."

Overseas, the European Central Bank left its key rate at 2.5%, and comments from ECB President Jean-Claude Trichet dampened speculation that the bank will aggressively raise rates this year.

Thursday's rate decision was expected, but the euro fell on Trichet's comments. The euro gained 2.3% in the first quarter on expectations that the ECB would narrow the gap between its target rate and the fed funds rate.

If the ECB raises rates enough to significantly narrow that gap, then the 10-year Treasury note would not be as relatively attractive to global investors looking for a decent return on a safe-haven investment.

A key reason why the U.S. bond market performed so well in recent years is that it has offered the highest return of debt markets worldwide. The comments from Trichet helped Treasuries come off their post-jobless-claims lows.

While he believes there's still plenty of liquidity "sloshing around," Shin says that the market is coming to believe that higher interest rates all over the world are an inevitability.

"There's been so much more chatter about the global drying of liquidity ... all of the central banks are really starting to play the same tune," says Shin. "That is throwing markets off."

Indeed, short-term rates in Japan rose sharply Thursday on news the nation's monetary base posted its first year-over-year decline since January 2001, evidence of tighter monetary conditions.