PARIS -- U.S. and European government bonds defied expectations as AFP reported by rallying strongly in 2000 due to stock market turmoil, the slowdown in the U.S. economy and expectations of short supply.

Many of the signs looked bad: After the slump in the bond markets of 1999, investors had to grapple central banks raising interest rates to prevent economies overheating.

The sharp rise in oil prices and the chronic weakness of the euro stoked fears of inflation, which eats away at the value of longer-term bonds.

Higher interest rates mean new bond issues will have higher rates of return than existing bonds, which then become less attractive.

Since November 1999, when the European Central Bank (ECB) began to tighten interest rates, its key refinancing rate has been raised by 2.25 percentage points to 4.75 percent.

Meanwhile the U.S. Federal Reserve's federal funds rate has been raised by 1.75 percentage points since June 1999 to 6.50 percent.

Yet the German fund has rallied during 2000. The yield, which moves inversely to price, has fallen by half a percentage point during 2000 to trade late Friday at 4.84 percent.

And the yield on benchmark 30-year U.S. bonds, known as treasuries, dropped even more dramatically to 5.412 percent late Friday from around 6.48 percent at the end of 1999.

The good performance by bond markets is partly due to improved investor confidence in central banks and their ability to keep inflation in check, experts said.

But the market also benefitted from a miserable year on the stock markets.

On Wall Street, the once high-flying NASDAQ electronic exchange, dominated by "new economy" high-tech and Internet issues, plunged 38 percent on the year while the Dow Jones industrials dropped 5.6 percent.

In Europe, London's FTSE 100 index fell 10 percent in 2000.

Investors burned by the "new economy" stocks took refuge in the less-risky government bond market.

In autumn, the sharp rise in oil prices, weakness of the euro and slowdown in U.S. economic growth forced companies to issue a rash of profit warnings; leading portfolio investors to increase their weighing in bonds.

At the end of the year, "everyone has been surprised by the speed with which the U.S. economic slowdown has arrived," sending inflation-sensitive long-term rates to their lowest levels since the financial crisis of 1998, said Caisse des Depots bond trader Pascal Coret.

Looking ahead, investors are expecting the U.S. Federal Reserve to cut interest rates in January.

U.S. treasuries have further benefitted from the U.S. Treasury's decision to buy back $30 billion in debt thanks to budget surpluses, leading to expectations of much of the paper being extinguished by 2012-2013.

With fewer treasuries available for investors, the price goes up and the yield comes down.

In Europe, the expected reduction in supply is due to huge revenues raked in by some governments from the sale of licences to run next-generation Universal Mobile Telecommunications System (UMTS) services for mobile telephones.

The French Treasury has said it plans to buy 10 billion euros worth of its own bonds.

But while top-Notch "AAA" rated government bonds have performed well, corporate bonds have had a miserable year as investors looked for bigger risk premiums, especially after telecommunications giants issued a huge number of bonds to buy the UMTS licences despite an uncertain outlook for profits.

"Some investors will remember and they will be more selective with their investments next year," Coret forecast.