TREASURIES-U.S. bonds fall on bets of brief federal shutdown
* U.S. government shutdown seen brief, a modest economic dent
* U.S. manufacturing grew at fast pace in 2-1/2 years - ISM
* U.S. Treasuries posted first monthly gain since April
NEW YORK, Sept 30 (Reuters) - U.S. Treasuries prices fell on Tuesday, as traders reduced their safe-haven bond holdings on expectations that the first partial government shutdown in 17 years would be brief, although a funding deal seemed elusive.
The U.S. government partially shut down for the first time in 17 years on Tuesday as a standoff between President Barack Obama and congressional Republicans closed national parks and slowed everything from trade negotiations to medical research.
If Congress can agree to a new funding bill soon, the shutdown would last days rather than weeks, with relatively little impact on the world's largest economy.
"It is more about political posturing. The market has crisis fatigue," said Bret Barker, portfolio manager at TCW Group in Los Angeles.
Traders also pared their bond holdings after the Institute for Supply Management's index on U.S. manufacturing showed the sector grew at its fastest pace in 2-1/2 years.
Benchmark 10-year Treasuries notes last traded down 7/32 in price with a yield of 2.643 percent, up 2.6 basis point from late on Tuesday.
The 10-year yield touched its lowest level in seven weeks on Monday, spurred by last-minute safe haven bids ahead of the partial government shutdown.
The Treasuries market earned 0.70 percent in total return in September posted its first monthly gain in September. This reduced its year-to-dated loss to 2.01 percent due to a sharp summer sell-off due to fears that the Federal Reserve might reduce its stimulus later this year, according to an index compiled by Barclays.
After Democratic and Republican lawmakers failed the reach a funding deal by the midnight deadline, selling led by hedge funds emerged in overseas trading, analysts and traders said.
While market reaction to the government shutdown has been muted so far, investors are more worried that the current gridlock in Washington would cause a government default if lawmakers do not agree on raising the $16.7 trillion borrowing limit, which is expected to be exhausted on Oct. 17.
"As we approach the Day Zero on the debt ceiling, we recommend buying more into Treasuries," said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.
For now, many traders do not anticipate the U.S. government will stop meeting its debt obligations, which are held in pension funds, retirement accounts and central banks worldwide.
"It's way too early to price in a technical default. That's a very long shot," said Mike Cullinane, head of Treasuries trading at D.A. Davidson in St. Petersburg, Florida.
In the derivatives market, the cost to insure against a U.S. default hovered at its highest level in more than four months. Investors would have to pay about 33,160 euros annually to insure 10 million euros worth of Treasuries against a default in five years, down from 33,217 euros on Monday's close, according to data from Markit.
Still a protracted government shutdown will subtract from economic activity with potentially up to one million workers being put on unpaid leave. Economists estimated each week of reduced federal services would take away 0.1 percentage point of the U.S. gross domestic product.
Early casualties of the partial government shutdown were official economic reports. The Commerce Department said on Tuesday it postponed the release of its September reading on construction spending.
The Labor Department said last week it will not publish the closely-watched employment report, which was slated for release on Friday, if a shutdown occurs. But it will put out its weekly jobless claims report on Thursday.
As a result, investors will rely on privately produced economic indicators, which include ADP's private employment report on Wednesday.