Updated from 1:30 p.m. EST

Treasuries came off their lows Thursday, as positioning ahead of the February payrolls left the market little changed. The government's $8 billion, 10-year note auction had little effect on the market, as traders were reluctant to make any large moves before Friday's jobs data.

The benchmark 10-year note ended the day flat to yield 4.73%, while the 30-year bond was also unchanged to yield 4.72%. The two- and five-year notes were also little changed to yield 4.72% and 4.74% respectively. Bond prices and yields move in opposite directions.

"We remain neutral on rates and the curve ahead of payrolls and recommend reducing risk ahead of the report," fixed-income strategists at Barclays Capital commented in a research note. "We believe the market will be more sensitive to the report this month than the last several months and would wait for the print before initiating new strategies."

Wall Street expects that 210,000 jobs were added in February, up from 193,000 in January, which would be consistent with a tightening labor market and more Fed hikes.

Fed policymakers have said the U.S. is close to full employment, the lowest level of unemployment possible before wage inflation sets in. Bond traders loathe inflation because it erodes the value of fixed-income investments.

Full Employment Debate

Earlier Thursday, weekly jobless claims numbers came in higher than expected, subduing fears that employment gains will set off wage inflation and prompt the Federal Reserve to raise rates too high.

Fed funds futures show traders are pricing in a 100% chance that the Fed will raise the overnight lending rate by a quarter point to 4.75% on March 28, in part due to recent employment data that has shown a tightening labor market. The contract also shows 82% odds for the rate to hit 5% at the May 10 Federal Open Market Committee meeting.

The weekly jobless claims report from the Labor Department showed that claims rose to 303,000 in the week ended March 4, above expectations for claims to fall to 290,000 from the prior week's 295,000 result. This is the first week that claims have surpassed 300,000 since Jan. 7, and it helped quell some wage-inflation fears.

But better employment numbers may not necessarily translate into a labor market boom.

"I think it's a given that recent job growth has been due to the booming housing market in the form of jobs in the construction industry, real estate brokerages and refinancing," says Michael Cheah, a portfolio manager with AIG Sun America Asset Management. "We've seen in the last three to four months the peaking of the housing market. It's a matter of time before jobs in housing boom-related industries begin to disappear."

Cheah doesn't believe that will show up in Friday's employment report for February, "but we know it's coming."

Matthew Smith, vice president and fixed-income portfolio manager with Smith Affiliated Capital, agrees that not enough economists are looking ahead to employment risks.

Along with the housing slowdown, Smith says troubles at General Motors ( GM) could cool previously hot employment reports.

"GM could suspend its contracts with the UAW because of bankruptcy, and there would be a walkout," he says. "The last time GM shut down in 1998, nonfarm payrolls went from 320,000 to 120,000 in a month.

"Other than the industrial numbers that have come out ... half the economic data has been down," Smith adds, referring to readings on housing and consumer sentiment.

Moreover, the Federal Reserve's own Survey of Consumer Finances shoots some holes into the theory that a stronger labor force could result in more spending and inflationary pressures. From 1998 to 2001, before-tax median family income -- expressed in 2004 dollars -- increased from $38,800 to $42,500, a nearly 10% gain, the survey found. Over the next three years, it rose only to $43,200, a 1.6% gain.

The report also found that the mean income level declined to $70,700 in 2004 from $72,400 in 2001, down 3.6%. The mean level rose from $61,700 in 1998 to $72,400 in 2001.

Cheah says that evidence of a short squeeze in Treasuries could also stem a major selloff as traders forced to cover short-selling push prices higher and higher.

"My guess is not many traders would want to pay punitive borrowing costs over the weekend. This could lead to some short covering," says Cheah. "It makes sense to buy back paper and lock in profits before tomorrow's roll of the dice," he adds, referring to the February payroll number.

Global headwinds

The recent bearish tone is in part due to evidence that rates are going higher in Europe and Japan, with the Bank of Japan saying overnight that it will scrap its easy-money policy. However, it also said that rates will stay close to zero as it readies for a rate hike down the road.

Smith says the takeaway here is the fact U.S. interest rates are still significantly higher than those worldwide.

"You have a 10-year yield at 18-month highs and a two-year that just came off a five-year high. These are positives," he says.

Until recently, Treasuries had been in rally mode in part because they offer more return than any other low-risk government security, but rising rates worldwide could erode their relative attractiveness.

Smith points out that the Treasury market was unmoved by the BoJ's announcement.

"It will take a long time for Japan's rates to catch up with ours, which are nearing 5%," he says. "The carry trade is not over," he says, referring to the practice of borrowing money at 0% from Japan and then reinvesting it into higher-yielding U.S. Treasuries (among other assets). Smith believes this will help keep long-term yields low, no matter how high the Fed takes the overnight lending rate.

The January trade deficit jumped to a record $68.5 billion as a strong 2.5% rise in exports was offset by a 3.5% jump in imports. The deficit came in $2 billion more than expected, and it starts the year and quarter off with a larger-than-expected drag on domestic growth.

China accounts for 26% of the trade deficit, NAFTA weighs in at 20% and OPEC stands at 12%.

The government's $8 billion, 10-year note auction had little effect on the market, as traders were reluctant to make any large moves before the February payrolls report.

The auctioned notes drew a yield of 4.76%, with a 2.87 bid-to-cover ratio, compared with a cover of 2.32 at the last reopened issue.

The sale also saw 5.5% on indirect bidder participation, vs. 17.1% at the last reopening

" Indirect bidders will not likely be major players at this reopening ... and the upcoming February payrolls release will likely temper any response to the results of the auction," David Ader, government bond strategist with RBS Greenwich Capital, predicted at the start of the session. RBS is one of 22 primary dealers required to participate in Treasury auctions.

He notes that 10-year reopenings see very little interest from indirect bidders, a category that includes foreign investors, with indirect bidders taking an average 15.4% of the awarded bids at the last four off-cycle auctions.

In corporate bond sales, automaker DaimlerChrysler ( DCX) sold $1.49 billion, or 1.25 billion euros, worth of seven-year notes.

Levi Strauss, Vodafone ( VOD) and Honeywell International ( HON) all announced upcoming debt auctions.

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