* ISM index shows manufacturing expanded in September
* Manufacturing grew for first time since May
* Construction spending in August declined
(Updates comment, prices) By Ellen Freilich
NEW YORK, Oct 1 (Reuters) - U.S. Treasuries prices slipped on Monday after a closely watched industry report unexpectedly showed manufacturing expanded in September for the first time since May.
The Institute for Supply Management said its index of U.S. factory activity rose to a reading of 51.5 in September as new orders and employment picked up. A reading above 50 points to expansion. Economists had expected the index to indicate contraction.
Treasuries, which had been modestly higher before the report came out, slipped slightly in price afterwards.
"The ISM manufacturing index says activity is back on the plus side in September, maybe QE3 is working after all," said Chris Rupkey, managing director and chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.
The Federal Reserve announced its latest round of quantitative easing, known as QE3, last month.
After the ISM index was released, the benchmark 10-year Treasury reversed course to trade down 2/32 in price before paring losses to trade unchanged from Friday's close. Its yield
stood at 1.64 percent, midway between a low of 1.38 percent set in late July and a high of 1.89 percent reached in mid-September.
The ISM index came in "sturdier than expected," said Pierre Ellis, senior economist at Decision Economics in New York, calling the strong increase in new orders the "major good news."
The good news, however, had a downside for Treasuries because it "means that any case for a near-term 'souping-up' of QE3 is weakened," Ellis said.
A weaker picture emerged for construction spending, which the government said recorded its biggest decline in a year in August.
An element of caution may also have limited the Treasury market's losses on the ISM manufacturing reading.
"The rise above 50 is encouraging, but it should be viewed in a conservative context," said Thomas Simons, money market economist at Jefferies & Co. in New York. "The sub-50 readings in June, July and August were all very close to 50 and this month's reading remains below the 53.5 reading in May, so the broad trend in the index looks intact. Manufacturing is stuck in neutral at the moment."
Markets were next awaiting a speech by Fed Chairman Ben Bernanke at 12:30 EDT about the U.S. central bank and monetary policy before the Economic Club of Indiana.
(Editing by Leslie Adler)
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((-------------- MARKET SNAPSHOT AT 1120 EDT (1520 GMT) ---------------------
Change vs Current Nyk yield Three-month bills 0.090 (-0.005) 0.091 6-month bills 0.130 (-0.005) 0.132 Two-year note 100-00/32 ( 00/32) 0.242 Five-year note 100-00/32 ( unch ) 0.625 10-year note 99-27/32 ( unch ) 1.638 30-year bond 98-07/32 (-08/32) 2.840 ))
Keywords: MARKETS USA BONDS/