TREASURIES-Bonds fall as stronger data drives view on Fed tapering
* U.S. jobless claims drop to 5-1/2-year low
* ISM manufacturing index at 2-year high
* Market focused on U.S. nonfarm payrolls data due Friday
NEW YORK, Aug 1 (Reuters) - U.S. Treasuries prices fell on Thursday as strong economic data supported the prospect that the Federal Reserve will trim monetary stimulus sooner, rather than later. A fall in the number of new U.S. claims for jobless benefits to a 5-1/2-year low in the latest week supported expectations that the government's jobs report for July, due to be released on Friday, will show solid payroll growth. The Institute for Supply Management (ISM) said its manufacturing index in July rose to its highest level in two years, with gains in both production and new orders. The single sour note was an unexpected 0.6 percent drop in construction spending in June. But the Commerce Department reported construction activity in the housing sector, whose recovery is considered key to the economic recovery, was up a strong 17.9 percent year-on-year. The bond market's retreat erased the gains on Wednesday, scored after the Federal Reserve gave no hint of a pullback in bond buying at the end of its two-day policy meeting. "After a dovish FOMC statement, bonds were hurt by a better-than-expected weekly claims report," said Cary Leahey, senior adviser to Decision Economics in New York. The Labor Department reported the number of Americans who filed new claims for unemployment benefits in the week ended Saturday fell by 19,000 to 326,000, well below economists' forecast for 345,000. The ISM manufacturing data and strong stock market gains also diminished the safety appeal of U.S. government debt. "The best ISM reading since June 2011, a pretty solid report in every way, and an S&P 500 stock index above 1,700, providing additional comfort on the economy, makes a September timing for tapering QE highly likely," said Thomas di Galoma, a head of bond trading at ED&F Man Capital Markets. The economic data encouraged traders to "set up short Treasuries positions for tomorrow's jobs report," he said. Benchmark 10-year Treasury notes fell 27/32 in price, driving yields up to 2.69 percent. The 30-year bond fell 1-16/32, with its yield rising to 3.73 percent. In its statement on Wednesday, the Fed said the U.S. economy continues to recover, but still needs support. For now, the U.S. central bank will keep buying $85 billion in mortgage and Treasury securities per month to bolster the economy.
Jeffrey Cleveland, economist at Payden & Rygel in Los Angeles, noted that the Fed's statement "was on the dovish side." Now the market is focused on "that looming payrolls number" on Friday, said Cleveland, whose firm oversees $80 billion in assets. Economists polled by Reuters estimated 184,000 jobs were added in July, fewer than the 195,000 added in June. "The payrolls data is the most important event of the week, and if we get stronger-than-expected employment, or unemployment declines more than expected, the market will think 'tapering' is alive and well and that we should be ready for it in September," said Wilmer Stith, co-manager of the Wilmington Broad Market Bond Fund in Baltimore. Stith said the market has already partially priced in the possibility that the Fed could begin to trim its large-scale bond purchases in September. "If the most significant piece of data in this whole tapering equation comes in stronger than expected, you'll have an increase in the probability of tapering, which will lead to higher interest rates and volatility," he said. U.S. Treasury yields have shot up since May, when policymakers began suggesting the Fed could slow the pace of its asset buying as the economy strengthens. The government on Wednesday reported the U.S. economy grew at a 1.7 percent in the second quarter, faster than expected, though the first quarter's expansion was revised down.