* 10-year Treasury yields hit lowest since July 2016
* All three major U.S. stock indexes slide
* U.S. factory activity contracted in August - ISM
* Safe-haven gold prices surge
* (Updates to U.S. market close)
By Stephen Culp
NEW YORK, Sept 3 (Reuters) - Benchmark 10-year U.S. Treasury yields fell on Tuesday to their lowest since July 2016 and all three major U.S. stock indexes lost ground in a risk-off session driven by heightened trade worries and an unexpected contraction of U.S. factory activity.
European shares also dipped over global economic slowdown worries and uncertainties surrounding Britain's chaotic exit from the European Union.
New tariffs on Chinese goods took effect over the U.S. holiday weekend. Hopes appear to be dimming that the world's two largest economies will reach a near-term resolution to their long-running trade war, which has shaken markets for months and strained world economies.
U.S. President Donald Trump said bilateral trade talks with China were going well, but warned he would be "tougher" if negotiations extend beyond the 2020 U.S. presidential election and he is re-elected.
U.S. manufacturing output shrank in August for the first time in 3-1/2 years, according to the Institute for Supply Management's Purchasing Managers Index (PMI), stoking fears that the global economic slowdown has reached American shores.
"Today we had economic data that's providing reinforcement to bearish economic argument, and it's the first trading day since new tariffs were put in place," said Chuck Carlson, chief executive officer at Horizon Investment Services in Hammond, Indiana. "People are seeing global economic slowdown coming to fruition and taking money off the table."
But Carlson cautioned against giving too much weight to market behavior on the first trading day following the unofficial end of summer.
"It's the first day back after August and you're getting the students back to class," Carlson added. "You'll have a better read next week."
The Dow Jones Industrial Average fell 285.26 points, or 1.08%, to 26,118.02, the S&P 500 lost 20.19 points, or 0.69%, to 2,906.27 and the Nasdaq Composite dropped 88.72 points, or 1.11%, to 7,874.16.
European stocks backed off from 1-month highs after the disappointing U.S. PMI data fueled worries of global economic softness, while uncertainty over Britain's hard exit from the European Union put an end to the FTSE 100's four-day winning streak.
The pan-European STOXX 600 index lost 0.23% and MSCI's gauge of stocks across the globe shed 0.52%.
U.S. Treasury yields fell, with the benchmark 10-year yield dipping to its lowest since July 2016 after the downbeat ISM report exacerbated worries about a weakening global economy in the shadow of the U.S.-China trade war.
Benchmark 10-year notes last rose 11/32 in price to yield 1.4708%, down from 1.506% late on Friday.
The 30-year bond last rose 7/32 in price to yield 1.9639%, down from 1.973% late on Friday.
Trade and Brexit concerns drove the dollar to its highest level against a basket of major currencies since mid-May 2017, but the greenback erased its gains following the dismal ISM factory data.
The dollar index rose 0.1%, with the euro down 0.01% to $1.0965.
The Japanese yen strengthened 0.14% versus the greenback at 106.08 per dollar, while Sterling was last trading at $1.2079, up 0.11% on the day.
The disappointing U.S. factory data also drove oil prices lower, as concerns over the weakening global economy undermined the demand outlook.
U.S. crude oil futures settled at $53.94 per barrel, down 0.68%, while Brent crude futures settled down 2.11% at $58.26 per barrel.
Gold prices surged more than 1%, with the safe-haven precious metal hovering within shouting distance of its more- than-six-year high of $1,554.56 per ounce.
Spot gold added 1.0% to $1,544.95 an ounce.
Copper lost 0.18% to $5,610.00 a tonne.
Three-month aluminum on the London Metal Exchange rose 0.34% to $1,755.00 a tonne.
(Reporting by Stephen Culp; Editing by Dan Grebler)