* Treasuries on track for first monthly gain since April
* Possible U.S. government shutdown in focus
* Worries over Italian government stoke safe-haven bids
* Chicago PMI highest since May, Dallas Fed index jumps
By Ellen Freilich
NEW YORK, Sept 30 (Reuters) - U.S. Treasuries prices rosemodestly on Monday, leaving yields just above their lowestlevels in seven weeks, aided by safe-haven bids on worriesabout a partial government shutdown.
The U.S. Congress, still in partisan deadlock on Monday overRepublican efforts to halt President Barack Obama's healthcarereforms, was on the verge of shutting down most of the U.S.government starting on Tuesday morning.
A shutdown would furlough most government employees and,analysts say, act as a drag on the U.S. economy.
The latest stalemate over the federal budget, together withthe Federal Reserve's decision to refrain from shrinking itsmonthly bond purchases earlier this month, have stabilized theTreasuries market following a summer sell-off.
"The market gapped higher at the open on overseas concernsabout the potential shutdown here in the U.S. and also thedifficulties with the government in Italy," said John Canavan,fixed-income analyst at Stone & McCarthy Research Associates inPrinceton, New Jersey.
Italy's former prime minister, Silvio Berlusconi, hadordered five center-right ministers to leave the government,threatening the governing coalition. But on Monday, as many as20 senators from Berlusconi's party were ready to form abreakaway group unless the former premier backs down on his hardline to bring down Italy's government.
This development subsequently curbed early safety bids forTreasuries, German Bunds and other low-risk assets.
U.S. government debt was on track to post its first monthlygain since April and to eke out its first quarterly rise since ayear ago, according to Bank of America Merrill Lynch.
"The (market) is pricing in a partial government shutdown,"said John Herrmann, director of interest rates strategy atMitsubishi UFJ Securities in New York.
A report from the Institute for Supply Management-Chicagothat showed business activity in the upper Midwest region grewat its fastest pace since May kept the bid for U.S. Treasuriesin check, however. In addition, the Dallas Fed said its gauge ofTexas manufacturing strengthened in September to its strongestlevel since early 2011.
In late trade, benchmark 10-year Treasury notes were up 3/32 in price, yielding 2.616 percent. They had been upas much as 11/32 earlier, yielding 2.59 percent.
"We are not in a complete risk-off world. It's a temporarymove to safety," Herrmann said.
Besides the wariness that fed a preference for U.S. debt -stock prices fell on Monday - month-end index-related buying andquarter-end portfolio rebalancing supported bonds, Canavan said.
Some traders still anticipated a possible last-minute dealin Washington to avert a government shutdown, which would causean unwinding of some safe-haven bond holdings.
"It's a very fluid situation," said Scott Graham, head ofU.S. government bond trading with BMO Capital Markets inChicago. "The market is trading in a tight range. People aregetting a bit tired of the situation."
The 10-year yield was on course to fall 16 basis points inSeptember for its first decline in five months, but it was stillset to rise for a fourth consecutive quarter.
Treasuries fared better than their German counterparts asthe yield premium on U.S. 10-year debt over 10-year Bunds shrankto 0.83 percent from 0.85 percent on Friday.
While a possible government shutdown has spurred bids forU.S. debt, a protracted shutdown, in addition to a looming fightover raising the $16.7 trillion debt ceiling, could damage thesafe-haven status of Treasuries and the U.S. dollar.
The cost to insure against a U.S. default rose to thehighest level since May. Investors would have to pay about35,500 euros annually to insure 10 million euros worth ofTreasuries against a default in five years, up from 31,000 euroson Friday's close, according to data from Markit.
While as many as 1 million federal workers could facepayless pay-days if lawmakers do not reach a deal to fund thegovernment, some branches of government, including the FederalReserve, will stay open.
The U.S. central bank bought $1.47 billion in Treasuriesthat mature in February 2038 to August 2043, the last of itsTreasuries purchases in September for its third round ofquantitative easing, or QE3.
The Federal Reserve Bank of New York's open market desk saidit plans to purchase approximately $45 billion in Treasurysecurities in October, as it did in September.
- government shutdown