TREASURIES-U.S. bonds slip on bets federal shutdown to be brief
* A brief government shutdown seen a modest economic dent
* U.S. manufacturing grew at fast pace in 2-1/2 years - ISM
* Treasuries posted first monthly gain since April in Sept
* U.S. 1-month bill sale fetches highest rate since November
By Richard Leong
NEW YORK, Oct 1 (Reuters) - U.S. Treasuries prices fell on Tuesday, as traders reduced their safe-haven bond holdings on expectations that the first partial government shutdown in 17 years would be brief, although a funding deal seemed elusive.
Federal agencies began cutting services after a standoff between President Barack Obama and congressional Republicans closed national parks and slowed everything from trade negotiations to medical research.
If Congress can agree to a new funding bill soon, the shutdown would last days rather than weeks, with relatively little impact on the world's largest economy.
"It is more about political posturing. The market has crisis fatigue," said Bret Barker, portfolio manager at TCW Group in Los Angeles.
Traders also pared their bond holdings after the Institute for Supply Management's index on U.S. manufacturing showed the sector grew at its fastest pace in 2-1/2 years.
Benchmark 10-year Treasuries notes last traded down 6/32 in price with a yield of 2.635 percent, up 2 basis point from late on Monday.
The 10-year yield touched its lowest level in seven weeks on Monday, spurred by last-minute safe haven bids ahead of the partial government shutdown. Still, bond yields have remained fairly contained despite jitters about the shutdown.
The Treasuries market earned 0.7 percent in total returns in September, its first monthly gain since April. The recovery last month helped lift the market's third-quarter performance into positive territory, also generating a 0.7 percent return. In turn, this reduced its year-to-date loss to 2.01 percent. The loss was tied to a sharp summer sell-off due to fears that the Federal Reserve might reduce its stimulus later this year, according to an index compiled by Barclays.
ONE-MONTH BILL RATE JUMPS
After Democratic and Republican lawmakers failed to reach a funding deal by the midnight deadline, selling led by hedge funds emerged in overseas trading, analysts and traders said.
While market reaction to the government shutdown has been muted so far, investors are more worried that the current gridlock in Washington would cause a government default if lawmakers do not agree on raising the $16.7 trillion borrowing limit, which is expected to be exhausted on Oct. 17.
"As we approach the Day Zero on the debt ceiling, we recommend buying more into Treasuries," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia, adding five-year issues have the most room to rally under the current climate.
But investors were reluctant to load up on ultra short-dated U.S. debt, which might face turbulence as the debt ceiling deadline looms.
At Tuesday's $35 billion sale of U.S. one-month T-bills, the Treasury paid 0.12 percent to investors, which was the highest interest rate paid on this debt maturity since November.
"Bills are one of the best measures of investor anxiety," said Tony Crescenzi, portfolio manager with PIMCO in Newport Beach, California. He said he was stunned by the jump in T-bill rates, noting how they had been at zero just days ago.
On the open market, the interest rate on one-month T-bills rose to 0.08 percent, up 5.5 basis points on the day. It was on track for its biggest single-day rise since late July 2011 in the days of the first debt ceiling showdown between President Obama and top Republican lawmakers.
For now, many traders do not anticipate the U.S. government will stop meeting its debt obligations, which are held in pension funds, retirement accounts and central banks worldwide.
"It's way too early to price in a technical default. That's a very long shot," said Mike Cullinane, head of Treasuries trading at D.A. Davidson in St. Petersburg, Florida.
In the derivatives market, the cost to insure against a U.S. default retreated from its highest level in more than four months. Investors would have to pay about 31,995 euros annually to insure 10 million euros worth of Treasuries against a default in five years, down from 33,217 euros on Monday's close, according to data from Markit.
Still a protracted government shutdown will subtract from economic activity with potentially up to one million workers being put on unpaid leave. Economists estimated each week of reduced federal services would take away 0.1 percentage point of the U.S. gross domestic product.
Early casualties of the partial government shutdown were official economic reports. The Commerce Department said on Tuesday it postponed the release of its September reading on construction spending.
The Labor Department said last week it will not publish the closely-watched employment report, which was slated for release on Friday, if a shutdown occurs. But it will put out its weekly jobless claims report on Thursday.
As a result, investors will rely on privately produced economic indicators, which include ADP's private employment report on Wednesday.
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