A weak jobs report briefly saw U.S. debt rally, but yields climbed back as investors worried inflation could stay hot if the Fed hikes less

Bad news finally worked in Treasurys' favor - but just for a little while.

A weak U.S. jobs report did what bad news hadn't done in a while: It made U.S. debt look like a safe haven again - albeit briefly.

U.S. Treasurys gave up an early rally on Friday after a weaker-than-expected jobs report initially sent investors rushing into government debt.

The yield on the 10-year Treasury note BX:TMUBMUSD10Y fell 8 basis points to 5.155%, before reversing the move by midday trading. The policy-sensitive 2-year yield BX:TMUBMUSD02Y erased an 8.4-basis-point drop and turned sharply higher to 4.820%, according to FactSet data. Bond yields and prices move in the opposite direction to each other.

Data from the Bureau of Labor Statistics showed that U.S. employers added 29,000 jobs in September, which was well below expectations. The unemployment rate also ticked higher to 4.2%.

"Friday's cool jobs report doesn't guarantee lower yields, because the underlying drivers - inflation and sky-high government debt - are not going anywhere," said Nic Puckrin, macro and cross-asset analyst and founder of the Coin Bureau. "That means Americans must prepare for the double whammy of higher unemployment and rising prices at the store and at the pump, right in time for the winter holidays."

Treasury yields had a "knee-jerk" reaction lower after Friday's employment report showed the pace of jobs growth was cooler than economists expected.

Still, the economy is doing "fine," Chris Galipeau, head market strategist at the Franklin Templeton Institute, told MarketWatch. His view is that the 10-year yield's recent climb above 5% comes from "real economic growth," rather than long-term inflation fears.

To be sure, the weaker-than-expected jobs report wasn't the only force at work to push Treasury yields sharply lower early Friday. Yields surged in the third quarter, and some investors considered Treasurys to be oversold heading into Friday's session. Portfolio rebalancing at the start of the new quarter may have steered some capital back into beaten-down Treasurys, helping fixed income catch a brief bid.

Yet the jobs report didn't change the big-picture issues facing the Federal Reserve: Inflation remains a concern, the energy shock from the Iran war still is playing out globally, and traders still expect more interest-rate hikes from the central bank.

Fed-funds futures on Friday suggested an October hike looks unlikely. However, there was almost an 87% chance that the Fed would raise its benchmark rate in December by at least a quarter of a percentage point, from its current target range of 3.75% to 4%, according to the CME FedWatch Tool.

"The data helped ease a bit of the pressure on the Fed to keep a hiking cycle in place, and now we can sit back and let the market determine risk on its own without the Fed having to get involved in setting the overnight rate higher for the time being," said Brian Mulberry, chief market strategist at Zacks Investment Management.

That also explains why stocks were holding their ground despite the leg higher in Treasury yields, Mulberry told MarketWatch via phone on Friday.

"Equities can go higher while the 10-year Treasury goes higher because the fundamentals of the economy are still reasonably strong," he said.

The uptick in Treasury yields also came as oil prices (CL00) (BRN00) bounced from their session lows, erasing most of their earlier losses and underscoring how quickly inflation concerns can resurface.

U.S. stocks were higher Friday afternoon, with the Nasdaq Composite COMP up 1.2%, the S&P 500 SPX up 0.7% and the Dow Jones Industrial Average DJIA 0.4% higher, according to FactSet data.

-Isabel Wang -Christine Idzelis