TREASURIES-Bonds gain as ISM data fuels Fed speculation
* Early price losses erased
* ISM manufacturing employment index contracts
* Influential U.S. payrolls report due Friday
* Economists estimate 165,000 jobs added in June
NEW YORK, July 1 (Reuters) - U.S. Treasuries traded slightly higher on Monday after a key manufacturing employment index fell in June, fueling speculation that the Fed could keep its bond buying program in place to support the labor market. U.S. manufacturing activity grew in June but hiring in the sector was the weakest in nearly four years, the Institute for Supply Management said on Monday. That could, in turn, signal weak numbers for Friday's nonfarm payrolls release. The drop in the ISM employment index "is a very negative development as it relates to the jobs picture going forward," said Thomas di Galoma, one of the heads of bond trading at ED&F Man Capital Markets. "It's not a very good sign for Friday's (U.S. employment) data." While economists polled by Reuters expect payroll additions of 165,000 jobs for June, the possibility of a disappointing figure on Friday could "definitely" lead investors to think the Federal Reserve will not slow its bond buys any time soon, said Wilmer Stith, co-manager of the Wilmington Broad Market Bond Fund in Baltimore. And if the Fed is not going to rush to the exit, why should anyone else, especially with yields much higher than they were a couple of months ago, he said. "The economic data was not too hot and not too cold. It doesn't paint a picture of the Fed tapering sooner or later so the market is taking advantage of these elevated yields," Stith said. "The 10-year Treasury yield is nearly 100 basis points higher than where it was two months ago. Those levels seem appealing when you get this innocuous type of data." The decline in the employment index was what caught the bond market's eye. The benchmark 10-year Treasury note, down 9/32 before the report, last traded up 4/32 in price to yield 2.473 percent. The 30-year bond rose 14/32 in price to yield 3.475 percent, from 3.499 percent late on Friday. The benchmark 10-year yield reached a 22-month high of 2.67 percent last Monday, above the 2.20 percent area it traded at before Federal Reserve Chairman Ben Bernanke spoke about winding down the U.S. central bank's bond-buying program, and well above the 1.60 percent level where it stood at the beginning of May. A subdued employment report is seen as positive for bonds because it might argue against the Fed slowing its bond purchases this year. Despite the higher, more appealing yields, Thomas Simons, money market economist at Jefferies & Co, said some investors would try to "lighten up" before Friday's employment report. "We will be looking to sell upticks in Treasuries throughout the week and we will be putting on spread wideners," he said. "Trading will be thin in the middle of the week with the (U.S. Independence Day) holiday," he added. Yields rose to two-year highs last quarter, the worst period since 2012 for Treasuries as measured by the iShares Barclays 20-year-plus exchange-traded fund, a popular bond ETF, which fell about 6.5 percent in the quarter, its biggest drop since the first quarter of 2012. The slump in U.S. Treasury prices began in May, gaining momentum when Bernanke suggested the Fed could be looking for an exit from its $85 billion a month bond-buying stimulus program. The selloff intensified when Bernanke emphasized that the Fed could slow its purchases this year as the economy improves. Bond funds have struggled in recent weeks. Investors in funds based in the United States pulled $8.62 billion out of taxable bond funds in the latest week, marking the first four-week streak of outflows since 2008, data from Thomson Reuters' Lipper service showed on Thursday. Richmond Fed President Jeffrey Lacker said on Friday markets would be volatile as investors absorbed news that the Fed will pull back bond buying later this year. He said that was a normal adjustment that should not derail growth.
(Additional reporting by Luciana Lopez; editing by Chizu Nomiyama, James Dalgleish and Diane Craft)