By Deborah Levine

Treasury prices headed higher, led by gains in short-term debt, after the Labor Department said the U.S. economy lost 524,000 jobs in December while the unemployment rate rose to the highest since 1993.

Declines in U.S. stocks also spurred safe-haven buying, leading investors toward government debt.

"We knew the economy was bad and I don't think it's going to get better soon," said William Chepolis, who helps manage $9 billion in fixed-income assets at DWS Investments. "People are buying Treasurys at these yields because it's a quality thing."

Yields on 10-year notes (UST10Y), which move in the opposite direction of bond prices, fell 7 basis points to 2.38%.

Two-year yields (UST2YR) fell 8 basis points to 0.75%. A basis point is 0.01%.

The unemployment rate rose to 7.2%, or 0.1% higher than the median estimate of analysts polled by MarketWatch. Economists predicted job losses would reach 535,000, though several traders said the market was bracing for losses closer to 600,000.

However, the release included revisions to the previous two monthly reports, showing more losses than previously stated. It also said the number of hours worked declined and part-time employment rose.

"While the market may have been braced for a weaker headline print, there is no way it can be construed as a better-than-expected report," David Ader, U.S. government bond strategist at RBS Greenwich Capital, wrote in an email.

Still, a bad jobs report could be negative for Treasurys as it may increase expectations for the amount of stimulus spending lawmakers propose. Analysts already expect the Treasury to issue more than $1 trillion in debt in the fiscal year that began in October.

"Coming in the midst of the debate about the appropriate size of fiscal stimulus in 2009, this report adds to the pressure to upsize the package, and thus the supply of Treasurys," said economists at RDQ Economics.

Ten-year yields are headed for a weekly decline from 2.41% last Friday even as the government auctioned $54 billion in notes. Yields have increased in the past three weeks.

Two-year yields have fallen from 0.88% on Jan. 2, as economic data has been poor and kept some investors in the relative safety of short-term Treasurys. The yield is on pace for the biggest drop since the week ended Dec. 12.

Mortgage debt

Longer-dated maturities have also been under pressure as investors follow the Federal Reserve in buying mortgage-backed securities.

The central bank said late Thursday that it bought $10.2 billion in assets from Fannie Mae (FNM), Freddie Mac (FRE) and other housing entities earlier this week, the first step in a program designed to lower mortgage rates and stabilize the housing market.

Separately, the Fed said foreign official and private investors have increased their holdings of so-called agency debt in the latest week, the first increase in 14 weeks.

Agency debt held by the Fed in custody for foreign investors increased by $700 million, according to data compiled by the Fed and released late Thursday.

That's the first increase, and followed last week's small decrease, since early October, when custody holdings went into freefall, said Lou Crandall, chief economist at Wrightson ICAP, in a research note.

"It remains to be seen whether foreign official holdings have actually stabilized, or whether this is just a brief lull in the long-term liquidation that began last summer," he said.

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