By Min Zeng 

U.S. Treasury bonds rallied Thursday as a flat reading in U.S. wage inflation bolstered expectations that the Federal Reserve would continue to be patient in raising interest rates.

The nonfarm employment report caught many investors off guard. Bond prices had sold off as economists had expected a gain in wage growth along with solid jobs expansion. Many data over the past few months have showed the U.S. economy is picking up speed after a shallow contraction during the first three months of the year.

The report not only showed a setback in wage growth but the pace of jobs growth--223,000--also slightly trailed market expectations. Many investors say the report doesn't buck the trend of an improving economic outlook, but it did bolster the case for the Fed to continue to monitor data before it starts raising benchmark short-term interest rates.

The prospect that the Fed may keep interest rates lower for longer encouraged investors to buy bonds. Investors and traders who had positioned for lower bond prices were forced to buy bonds to cover soured wagers.

The price rally sent the yield on the benchmark 10-year Treasury note to as low as 2.368%, compared with 2.47% right before the report which was near a nine-month peak. Yields fall as prices rise.

In recent trading, the yield was 2.379%. It was 2.416% Wednesday.

"The report didn't meet lofty expectations and turned the bond market around," said Mike Lorizio, senior fixed income trader at Manulife Asset Management which has $383 billion Canadian dollars ($304.8 billion) in assets under management. "The Fed needs to see inflation continue to move from low levels before raising interest rates."

After a strong price rally during the first quarter, demand for ultrasafe U.S. government debt has soured, sending bond yields higher over the past few months. Sign of improving growth outlook in the U.S. and Europe, fading worries over deflation in the eurozone and growing concerns over bonds' valuations all soured demand on the haven debt market.

Many investors have been shedding their bondholdings to prepare for the Fed's rate-increase campaign for the first time since 2006. They are concerned that the Fed's tightening campaign would shrink the value of outstanding bonds.

Fed officials have been cautious in shifting into higher interest rates. Inflation indicators have been running below their 2% target. Global growth outlook remains uneven. The uncertainty over Greece's debt crisis, which has fueled broad market swings over the past few month--complicated the Fed's deliberations.

Fed-funds futures, which are used to place bets on central bank policy, showed Thursday that investors and traders see a 10% likelihood of a rate increase at the September meeting, compared with 17% before the jobs report, according to CME Group.

The odds for a rate increase at the December meeting were 49%, compared with 59% before the data.

Zhiwei Ren, managing director and portfolio manager at Penn Mutual Asset Management Inc., which has $20 billion assets under management, said a rate increase in September can't be completely ruled out.

Mr. Ren said he is sticking to his positioning for higher bond yields. Friday's jobs report "is a one-off and inconsistent with other reports on a stronger economy," he said. "This doesn't change the big picture of the U.S. economy."

The U.S. bond market will be shut on Friday to observe the Independence Day holiday. In the near term, analysts say investors need to gird for more volatility in financial markets ahead of the Sunday referendum on whether Greece will accept austerity measures demanded by creditors in exchange for further aid.

"It is uncharted territory," said Erik Weisman, portfolio manager at MFS Investment Management, which has $450.4 billion under management at the end of May. "You had better keep your position close to home due to the uncertainty.

Mr. Weisman said Treasury bonds could sell off if Greek people vote yes to the referendum as this would be perceived as a dial-back of the debt crisis. A "no" vote would generate a fight into Treasury debt, he said. But he added that if this outcome leads to a change in Greek government and a more willing leadership to reach a resolution, it could ease Greece's debt crisis.

Many investors still cling to hopes that a resolution will be reached between Greece and its international creditors--the European Union, the ECB and the International Monetary Fund--to avoid the risk of Greece leaving the eurozone. Investors are concerned that if Greece departs the eurozone, it would threaten the stability of the financial system in the bloc and generate broad repercussions in global markets and economic growth.

Write to Min Zeng at min.zeng@wsj.com