TREASURIES-Yield curve steeper on weak manufacturing, construction data

(New throughout)

BOSTON, Dec 2 (Reuters) - The Treasury yield curve was steeper on Monday following two reports showing U.S. factory activity and construction spending fell unexpectedly, sounding a cautionary note on the U.S. economy despite a recent string of upbeat data.

The Institute for Supply Management (ISM) said its index of national factory activity dropped 0.2 point to a reading of 48.1 last month. A reading below 50 indicates contraction in the manufacturing sector, which accounts for 11% of the U.S. economy.

In a separate report on Monday, the Commerce Department said construction spending dropped 0.8% as investment in private projects tumbled to the lowest level in three years. Data for September was revised to show construction outlays declining 0.3% instead of rising 0.5% as previously reported.

The U.S. yield curve, measured as the difference between the yields on two- and 10-year Treasury notes, was at 20.9 basis points, up 4.9 basis points from Friday’s close.

The steepening was driven primarily by a dip in the two-year yield, which retraced most of the early morning’s gains on strong data out of China. It was last at 1.620%, up 1.8 basis points on the day, though 3 basis points off the session high it hit in early trade.

The two-year yield reflects market expectations of changes in interest rates, suggesting Monday’s data complicates the conversation for the Federal Reserve’s policymaking meeting next week, without necessarily changing the odds of a cut in interest rates.

“This raises the stakes for the non-manufacturing and non-farm payrolls figures later this week, though we’re highly doubtful even underwhelming reads would be sufficient to goad the FOMC into cutting rates in just nine days,” said Jon Hill, U.S. rates strategist at BMO Capital Markets.

The benchmark 10-year yield, which reflects the market’s view of the broader state of the economy, largely shrugged off the reports and held most of its early gains. The 10-year yield was last at 1.831%, up 5.5 basis points on the day.

“Overall, it seems like the market doesn’t want to stray too much,” said Justin Lederer, Treasury analyst and trader at Cantor Fitzgerald.

He noted how yields on 10-year Treasuries had reached above 2% recently, but said traders are waiting to hear from the Fed about interest rates next week.

“It feels like we held 2% a few weeks ago. Now it will take a lot for us to break above that,” he said.

Reporting by Ross Kerber and Kate Duguid; Editing by Nick Zieminski and Dan Grebler