* Manufacturing indexes, stocks gain dent demand for bonds
* U.S. manufacturing grew at fast pace in 2-1/2 years - ISM
* Italy, Spain, Portugal debt rally hurts bid for Treasuries
* Bond market more focused on debt ceiling than shutdown
* U.S. 1-month bill sale fetches highest rate since November
By Ellen Freilich
NEW YORK, Oct 1 (Reuters) - U.S. Treasuries prices fell onTuesday as strong manufacturing indexes, stock market gains, anda rally in peripheral European debt all dented demand forTreasuries, still seen as a safe-haven despite a partial U.S.government shutdown and impending debt ceiling battle.
U.S. manufacturing grew last month at its fastest pace innearly 2-1/2 years. Manufacturing grew in Italy and Spain, theeuro zone's third and fourth-largest economies, as it did inGermany, Europe's largest economy. U.S. stocks rose despitethe U.S. government shutdown.
The debt of Italy, Portugal and Spain rallied on signs theItalian government would muster enough support in a confidencevote to ward off a new round of hotly contested elections.
The market impact from a stalemate over the U.S. federalbudget that caused the first partial U.S. government shutdown in17 years was mainly seen at the short-end of the maturity curvewhen a U.S. one-month bill sale got the highest rate sinceNovember.
"Globally, manufacturing survey data was relatively strong.The U.S. number beat expectations and last month's number andthat created some optimism," said Jake Lowery, Treasury trader at ING U.S. Investment Management in Atlanta.
Reports that Italy's government looked likely to survive aconfidence vote helped peripheral bonds, he noted.
"That reduced demand for safe-haven assets like Treasuriesand German bunds," Lowery said.
The partial shutdown of the U.S. government, which could putup to 1 million workers on unpaid leave and hurt U.S. and global growth, prompted a variety of views.
Lowery said for now, bonds were paying more attention to thedebt ceiling deadline than to the government shutdown. Treasurybills maturing on Oct. 31, soon after the Oct. 17 deadline citedby the U.S. Treasury Department for raising the debt ceiling,have "cheapened significantly," he said.
If Congress agrees to a new funding bill soon, the shutdownwould have relatively little impact on the world's largesteconomy.
But without that, markets could soon feel an informationdeficit as the shutdown deprives them of the fresh governmentdata on the economy to which they are accustomed.
"People say the bond market does not move much on themonthly economic reports, but boy when we don't have them, thetone of trading - if not the volume - drops dramatically," saidChris Rupkey, managing director and chief financial economist atBank of Tokyo-Mitsubishi UFJ in New York.
"Wall Street clients move money and buy and sell securitieswhen they change their view. Without the government economicreports, there is no reason to change your view," he said.
"A bad quarter for fixed income trading and commissions isgoing to get even worse in the days ahead," Rupkey said.
Rupkey said the shutdown "could last three weeks like thelast time.
"They really can't start it again without resolving the debtceiling limit problem, and (the deadline for)that, according toTreasury, is October 17," he said.
Amid the uncertainty created by the U.S. government shutdownand imminent debt ceiling battle, Wells Fargo Advantage Fundschief fixed-income strategist James Kochan said cash remained expensive relative to nominal Treasuries.
With the Federal Reserve in no hurry to raise short-terminterest rates, "cash will underperform for another two years,as it has for the past four," he said.
Predictions of negative returns for bonds once the Fedstarts to tighten monetary policy do not give enough weight tothe role "today's exceptionally steep yield curve could play infuture bond performance," Kochan said.
In six postwar periods of Fed tightening, a steep yieldcurve has flattened "significantly" by the end of the tighteningcycle, he observed. The steep yield curve plus coupon income ivecould still give investors positive returns even if bond pricesdecline somewhat, he said.
The Treasuries market earned 0.7 percent in total returns inSeptember, its first monthly gain since April. The recovery lastmonth helped lift the market's third-quarter performance intopositive territory, also generating a 0.7 percent return. Inturn, this reduced its year-to-date loss to 2.01 percent. Theloss was tied to a sharp summer sell-off due to fears that theFederal Reserve might reduce its stimulus later this year,according to an index compiled by Barclays.
On Tuesday, Day 1 of the U.S. government shutdown, benchmark10-year Treasuries notes fell 8/32 in price. Theiryields rose to 2.65 percent from 2.61 percent late on Monday.
The 10-year yield touched its lowest level in seven weeks onMonday, spurred by last-minute safe-haven bids before thepartial government shutdown.
ONE-MONTH BILL RATE JUMPS
While reaction to the government shutdown has been muted sofar, investors worry the conflict in Washington would cause agovernment default if lawmakers do not agree to raise the $16.7trillion borrowing limit, expected to be reached on Oct. 17.
Investors seemed reluctant to load up on ultra short-datedU.S. debt, which might face turbulence as the debt ceilingdeadline looms. At Tuesday's $35 billion sale of U.S. one-monthT-bills, the Treasury paid 0.12 percent to investors, thehighest rate paid on this debt maturity since November.
On the open market, the interest rate on one-month T-bills rose to 0.08 percent, up 5.5 basis points on the dayand on track for its biggest single-day rise since late July2011 in the days of the first debt ceiling showdown betweenPresident Obama and top Republican lawmakers.
For now, many traders do not expect the U.S. government tostop meeting its debt obligations, which are held in pensionfunds, retirement accounts and central banks worldwide.
"It's way too early to price in a technical default. That'sa very long shot," said Mike Cullinane, head of Treasuriestrading 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 fourmonths. Investors would have to pay about 31,995 euros annuallyto insure 10 million euros worth of Treasuries against a defaultin five years, down from 33,217 euros on Monday's close,according to data from Markit.
Early casualties of the partial government shutdown wereofficial economic reports. The Commerce Department said onTuesday it postponed the release of its September reading onconstruction spending.
The Labor Department said last week it will not publish theclosely-watched employment report, which was slated for releaseon Friday, if a shutdown occurs. But it will put out its weeklyjobless claims report on Thursday.
As a result, investors will rely on privately producedeconomic indicators, which include ADP's private employmentreport on Wednesday.
Economists estimated each week of reduced federal serviceswould take away 0.1 percentage point of the U.S. gross domesticproduct.
- government shutdown