Bond prices had initially edged higher on pre-weekend short-covering but quickly bowed to bouts of fresh selling when the first of the day's data showed the U.S. housing market defying all predictions of a slowdown.

Housing starts rose 3.4 percent in September to 1.89 million, beating forecasts for a steady 1.82 million and adding to already high expectations for GDP growth last quarter.

Still to come is the University of Michigan's consumer sentiment index, which is seen at a median 88.0 in October, little changed from September's 87.7.

Given the run of upbeat economic news recently, dealers can only assume the risks are for an upside surprise and yet more pressure on bonds.

The bond market is still pressured by San Francisco Federal Reserve President Robert Parry that an accommodative policy did not necessarily mean interest rates would stay at their current super-low 1.0 percent.

Market traders have suspected all along that some in the Fed thought rates could be higher, say at 2.0 percent or 3.0 percent, and still be accommodative. But this was the first time a top central bank official has acknowledged the idea.

The net result was a sharp rise in short-term yields, a marked flattening in the yield curve and a sell-off in Eurodollar futures as the market priced in a greater chance of higher rates, sooner.

More Fed speakers will be heard Friday, with governors Ben Bernanke and Donald Kohn discussing inflation targeting at a St. Louis Fed conference.

The market took some comfort in figures late Thursday showing foreign central bank holdings of Treasury and agency debt had topped $1.0 trillion dollars, up from $806.68 billion just a year ago and equates to roughly 10 percent of U.S. gross domestic product (GDP).

In all, the Federal Reserve's custody holdings for offshore central banks jumped $9.38 billion in the week to Wednesday, with Treasurys making up the majority.

The bulk of that demand comes from Asian central banks buying dollars to limit export-damaging gains in their currencies and traders were relieved to see that these flows had not slackened despite pressure from the White House to let the currencies float freely.

Still, having so much U.S. debt in so few hands made some traders sweat.

"It would be bad enough if these guys just stopped buying, what with all the new paper the government's issuing and the likely impact on the dollar," said one trader at a U.S. primary dealer. "But can you imagine if they actually started selling?"

Market Close

The bond market is continuing to hold its ground.