Updated from 11:21 a.m. EST

The Treasury market unraveled Thursday, beaten up by government reports showing a drop in jobless claims and an increase in one of the Federal Reserve's most closely watched inflation measures, as traders got cautious ahead of Friday's personal income and spending reports.

Wall Street economists expect that personal income rose by 0.5% in February, and that personal spending edged higher by 0.1%. Two manufacturing reports are also to be released Friday, with February factory orders expected to rise by 1.3% and the March Chicago Purchasing Manufacturers Index to come in at 58.0, up from 57.0 in the previous month.

"There are more legs to this economy than most people realize," says Steve Bohlin, a portfolio manager with Thornburg Investment Management. "The Fed has been removing accommodation, and so far they really haven't been restrictive: The Fed hasn't slowed down the economy yet."

The benchmark 10-year note ended the day down 13/32 to yield 4.86%, the highest since June 2004 and significantly higher than its 2006 low of 4.29% hit in January. Bond prices and yields move in opposite directions.

The 30-year bond sank 27/32 to yield 4.90%, the highest since March 2005. The five-year lost 7/32 to yield 4.83%, the highest level since March 2002, and the two-year edged lower two ticks to yield 4.83%.

David Ader, government bond strategist at RBS Greenwich Capital, says a $1 billion 50-year bond sale by the Tennessee Valley Authority has helped push prices down on the long end.

Yields across the curve hit multiyear highs, extending losses that began after the Fed raised its overnight bank lending rate this Tuesday to 4.75% from 4.50%, its 15th straight quarter-point rate hike. Policy makers said in a statement that more tightening may be needed to contain inflation.

Gold, often considered a hedge against inflation, hit a 25-year high, which helped fuel worries that the Fed will have to maintain a hawkish stance.

Crude oil prices rose to an eight-week high and gasoline nearly touched a six-month high, prices that made inflation watchers worry. Fed policy makers have said they are closely monitoring energy prices to see if they eventually work their way into core consumer prices and "add to inflation pressures."

Underscoring Bohlin's point, the Commerce department released its second revision to fourth-quarter GDP numbers, which was upwardly revised to 1.7%, in line with Wall Street expectations.

But the core personal consumption expenditures (PCE) price index, one of the central bank's favorite inflation indicators, rose at an annual rate of 2.4% in the last quarter vs. the 2.1% pace earlier reported. The measurement of prices tied to consumer spending rose at a 1.4% annual rate in the prior quarter.

Fourth-quarter corporate profits jumped 14.4% to post a 21.3% year-on-year gain. The Commerce Department said the quarterly rate of increase in after-tax profits was the strongest for any three months since an 18.9% jump in the fourth quarter of 2001. The strong gain follows a Hurricane Katrina-related decline in the third quarter.

Strong balance sheets allow companies to absorb rising input costs and could create a case for strong business investment in 2006.

In other economic news, the Labor Department said that weekly initial jobless claims fell by 10,000 to 302,000 vs. consensus estimates for claims to come in at 305,000.

"There is sustained growth in these numbers," says Bohlin, who believes the Fed will take the rate to 5.25%.

Fed funds futures are pricing in 100% odds that the Fed will raise the overnight lending rate another quarter-percentage point to 5% at its May meeting. The odds of a move to 5.25% at the June meeting are about 20%, up from 0% at the beginning of the week.

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