Treasuries ended an abbreviated session sharply higher, with most yields at their lowest levels of the year, after two pieces of economic news convinced investors that the

Fed is unlikely to hike interest rates again. The benchmark 10-year note's yield dropped to its lowest level in over a year.

The

employment report

(

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source

) and the

Purchasing Managers' Index

(

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source

), both for August, depicted an economy growing at a slower pace and untroubled by inflation.

As the odds of another hike in the

fed funds rate this year implied by the prices of

fed funds futures prices slipped to 5% from 36% yesterday, Treasuries shot higher in price.

(Wall Street economists aren't nearly so optimistic -- yet. In a

Reuters

poll this afternoon, eight of 27 economists sureyed said the Fed would hike the fed funds rate by the end of the year. An additional nine said a hike would come next year. Only four said the Fed's next move would be to cut rates.)

The benchmark 10-year note gained 11/32 to 100 16/32, dropping its yield 4.8 basis points to 5.681%, the lowest since July 21, 1999. Shorter-maturity issues rallied even harder, as they typically do when the monetary policy outlook is improving. The two-year note gained 7/32 to 100 3/32, dropping its yield 8.9 basis points to 6.074%, the lowest since Dec. 14. And the five-year note rose 9/32 to 103 13/32, dropping its yield 7.3 basis points to 5.902%, the lowest since Nov. 15.

The 30-year bond, however, gained only 1/32 to 108 12/32, trimming its yield a fraction of a basis point to 5.663%. The bond closed at its lowest yield of the year, 5.657%, on Aug. 25. An improving monetary policy outlook often benefits shorter-maturity issues at the expense of long ones.

At the

Chicago Board of Trade

, the December

Treasury futures contract added 5/32 to 100 19/32.

The August jobs report showed that netting out jobs lost temporarily because of a strike by

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workers, private-sector payrolls grew by 102,000. That compares to an average of 190,000 over the previous 12 months and 202,000 a month in 1999, indicating a substantial slowdown in the pace of job-creation.

The jobs report also showed that wage growth continues at a nonthreatening pace.

Average hourly earnings

increased 0.3%, in line with expectations, as the annual rate edged up to 3.8% from 3.7%.

Finally, it showed that the unemployment rate edged up to 4.1% from 4%, further indicating cooling of the labor market.

The Purchasing Managers' Index provided further evidence of an economic slowdown, although its results had been foreshadowed

Thursday by the

Chicago Purchasing Managers' Index

(

TheStreet Recommends

definition |

chart ). The PMI fell to 49.5 in August from 51.8 in July, its first sub-50 reading and the lowest reading since December 1998. A sub-50 reading signifies that the sector is slowing rather than growing.

While not as feeble as its Chicago cousin, the national report also provided broad-based evidence of manufacturing sector weakness and lack of inflation. Most notably, a sub-index measuring prices paid by manufacturers tumbled to 56.2 from 61.9.

Treasuries of all maturities rose on the news. The rally faltered around midday. Charles Parkhurst, co-head of government bond trading at

Salomon Smith Barney

, said there was "some talk of corporate deals being hedged up," meaning that underwriters of new corporate bonds expected to be sold next week were selling Treasuries as a hedge against a move down in prices. Also, Parkhurst said, Treasury bond futures traded up to a level (101) that triggered profit-taking.

But, in the final hours of the session, Treasuries rose anew, with the shortest-maturity issues faring best. The outperformance of the shortest-maturity issues brought the 10-year note's yield within 2 basis points of the 30-year bond's yield, the smallest difference since the Treasury yield curve started inverting in January.

The outperformance of the shortest-maturity Treasuries is a classic reaction to fading prospects for interest-rate hikes. "The curve should steepen" -- meaning that short-tern yields should decline relative to long-term ones -- "if the Fed is on hold, which it should be with numbers that are relatively weak," Parkhurst said. "Fed interest-rate hikes have the largest effects on the short end. That caused short yields to ratchet up relative to the long end. Now we're seeing a reversal of that."

"It's more of a curve trade than a market trade,"

UBS Warburg

Treasury market strategist Mark Mahoney concurred. Today's economic news "is going to change expectations with regard to the Fed so much that the intermediate sector will outperform the long end."

Economic Indicators

In other economic news, the

Future Inflation Gauge

(

definition |

chart ) slipped to 121.1 in August, the lowest since November, from a revised 121.7 in July.

Construction spending

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source

) fell 1.6% in July, matching its April decline, which was the largest since 1994. Both private and public construction fell. The annual pace of construction spending growth fell to 2.8%, the lowest since November 1997, from 5.7%.

The

Consumer Sentiment Index

(

definition |

chart ) fell to a revised 107.3 in August from 108.3 in July.

Currency and Commodities

The dollar fell against the yen and the euro. It lately was worth 105.94 yen, down from 106.67. The euro was worth $0.8982, up from $0.8886. For more on currencies, see

TSC's

Currencies column.

Crude oil for October delivery at the

New York Mercantile Exchange

rose to $33.40 a barrel from $33.12.

The

Bridge Commodity Research Bureau Index

fell to 222.48 from 227.41.

Gold for December delivery at the

Comex

fell to $280.90 an ounce from $282.10.