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Tensions deflate bond rally

A tumultuous rally in bond prices was deflated Friday by tensions in the Middle East that offset an encouraging employment report and made investors jittery that energy prices would skyrocket and revive inflation.

Analysts said the reversal in bond prices also may have been caused by investors selling to cash in on an impressive rally and by concerns that the market may have overreacted to the employment report."The market just got ahead of itself this morning, said Michael Strauss, chief economist at Sanwa Securities (USA) Co.

Bonds had shot up nearly 2 points, pushing yields to the lowest level in more than 19 months, after the Labor Department said the job market posted modest gains in September and wage inflation remained relatively mild.

The report of economic strength without rekindled inflation was better than many economists had expected. It added to a flurry of other evidence that suggests the economy will not overheat, something that would lead the Federal Reserve to raise interest rates.

But bonds pared their gains on concerns about rising oil prices and a United States decision to send the aircraft carrier USS Nimitz to the Persian Gulf as quickly as possible. The orders are linked to U.S. warnings to Iran earlier this week not to repeat air attacks into southern Iraq.

The benchmark 30-year Treasury bond ended the trading day with a gain of just 1/32 point, or 31 cents for each $1,000 in face value. Its yield hovered around Thursday's late rate of 6.29 percent, which matched the yield on July 31, the lowest this year.

Earlier in the day, bonds had soared as much as 17/8, or $18.75 per $1,000 invested, and yields fell to 6.16 percent - the lowest since reaching that level on Feb. 16, 1996 - after the government report suggested the job market may be losing steam and wages remain well-behaved.

The Labor Department said employers added 38,000 fewer jobs in September than August, when adjusted for the effects of the United Parcel Service strike and an early return of many school employees. Moreover, the unemployment rate was unchanged at 4.9 percent and wages were contained.

Investors welcomed the news of a softening employment market because they were worried tight conditions could push up labor costs and aggravate inflation. Higher inflation could prompt the Fed to raise interest rates to cool things down.

The Fed raised rates once this year - in March - but opted to remain on the sidelines as recently as Tuesday because inflation remains benign and there are some signs the economy may cool down on its own. Inflation and higher interest rates erode the fixed returns that bonds pay.

Although it may allow the Fed to delay raising interest rates through the end of the year, Strauss said, the jobs report still suggests the economy will expand at a healthy 3.5 percent pace in the second half of the year.

As long as the unemployment rate remains below 5 percent and until there is a series of weak readings on job creation, the Fed will be cautious about then potential for inflation, Strauss said.