(Updated from 2:33 p.m. EDT)

U.S. Treasuries gained strength on Thursday after the latest data on the labor market and manufacturing sector showed more economic weakness than expected.

Initial jobless claims climbed to 419,000 in the week ended May 26, from 411,000 the previous week, the government reported this morning. And the

Chicago Purchasing Managers' Index dipped to 38.7 in May from 38.9 in April, lower than the consensus forecast among economists of 40. Readings of this measure that fall below 50 show the manufacturing sector of the economy is contracting, as it has been for months.

The reports gave bond investors confidence the

Federal Reserve will continue cutting interest rates. They foreshadow tomorrow's release of the closely watched

employment report by the

Labor Department

and the

National Association of Purchasing Management's

Purchasing Managers' Index, a national read of the manufacturing sector.

Treasury prices rose and yields fell as investors swooped in to pick up government securities ahead of the reports. The two-year note, which reacts most dramatically to expectations of changes in monetary policy, recently gained 4/32 to 100, moving its yield down to 4.238%. The

10-year benchmark note gained 23/32 to 96 29/32, putting its yield at 5.411%. The 30-year bond, otherwise known as the long bond, climbed 30/32 to 94 12/32, lowering the yield to 5.773%.

The Fed next meets on June 26 and 27. It has already cut interest rates five times since the year began, putting short-term rates at 4%. "People are thinking that a 25 basis point cut

by the Fed is very possible," said Gib Clark, a trader at

Zions First National Bank




state of the economy remains elusive given that cross streams of recent economic data have indicated both economic recovery and sluggishness. Recent data, for example, show that consumer spending remains relatively healthy. And the latest reading of the

consumer confidence index for May came in above expectations. Indeed, Treasuries fell on Tuesday after the consumer confidence numbers were released and doubts crept into the market about whether the Fed would keep up its aggressive rate cuts.

But unemployment has been rising over the past few months. Economists surveyed by


expect the number of workers on non-farm payrolls to fall by 17,000 in May, following declines in the total number of jobs in April and March. The unemployment rate, which will be released before the market opens tomorrow, is expected to climb to 4.6% from 4.5% in April.

The bond market is a good proxy for expectations about future economic conditions. And the rising prices today reflect that expected weakness in tomorrow's economic figures will lead to additional rate cuts -- and continued strength in government securities, particularly on the short end of the market. In tandem with the Fed's five rate cuts since the beginning of the year, the short end of the Treasury market has been outperforming the long end. Bond market pros said today's gains in Treasuries are also partly technical, as index managers made month-end adjustments to their portfolios.

Despite today's price gains, which push yields lower, action in the long-end of the bond market has generally reflected investors' growing concerns about inflation. Inflation is bad for longer-term, fixed-income securities like bonds, which make set payments for a certain time period. The higher the market's expectations for inflation, the less money investors will pay for bonds -- and the higher the yield.


recently looked at the

bond market's take on the inflation outlook.

Core consumer inflation is rising at a 2.6% annual rate, just off a four-year high. Tony Crescenzi, chief bond strategist at

Miller Tabak

, believes investors have "shaved off a little" of their expectations about how quickly inflation is rising.

But Larry Berman, treasury strategist at

CIBC World Markets

, sees evidence of an uptick in inflation. "The Fed's easing cycle has been bearish for the long end of market," he said. "The market's oversold in general,

and it's getting a little bit of a bounce today."