TREASURIES-US bonds slide as selling in Japan spills over; Merck deal weighs on market

(Adds analyst comment and background, updates yields in paragraphs 5-6, 9, 12-13, 18-19)

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BOJ chief Ueda's remarks weigh on Treasuries

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Corporate issuance triggers selling of Treasuries

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US 2/10 yield curve steepens

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US manufacturing contracts for ninth straight month

By Gertrude Chavez-Dreyfuss

NEW YORK, Dec 1 (Reuters) - U.S. Treasuries fell on Monday, pressured by weakness in Japanese and European government bonds following comments from Bank of Japan Governor Kazuo Ueda, who signaled that conditions were aligning for a possible interest rate hike.

Bond yields rise when prices fall.

Ueda started the ball rolling in terms of the bond selloff, saying on Monday that the BOJ would consider the "pros and cons" of raising rates at its next policy meeting. His remarks provided the strongest hint so far that a hike may materialize this month. When Japanese government bond yields rise as a result of a rate hike, Japanese investors have less incentive to buy foreign bonds and more reason to bring money home. Japan is the largest non-U.S. holder of Treasuries, owning about $1.2 trillion of U.S. government debt.

"Japan made it clear that they're going to raise rates to support their currency here. So given their holdings of Treasuries, that does influence the U.S., said Stan Shipley, fixed income strategist at Evercore ISI in New York.

"And if Japan doesn't sell Treasuries, they're going to push their rate structure higher, encouraging investors over there, not to buy U.S. bonds, but to buy Japanese bonds," he added.

In addition, the yen is the funding currency for global carry trades and leveraged fixed-income arbitrage. When the BOJ raises rates, the cost of yen borrowing rises, forcing leveraged investors to unwind positions, including selling global bonds.

Japanese two-year yields, the most sensitive to the BOJ's policy rate, crossed 1% on Monday for the first time since 2008, while 10-year yields surged to a 17-year high.

The selloff in Treasuries further accelerated as U.S. corporate bond issuance picked up, led by Merck (MRK), with an $8 billion corporate bond deal, analysts said.

Wall Street dealers typically hedge corporate bond deals by selling Treasuries to lock in borrowing costs before issuance. Once the bonds are priced and sold, dealers unwind those hedges by buying back Treasuries, which can reverse some of the upward pressure on yields. However, the timing and scale of issuance flows often exacerbate intraday volatility, especially when layered on top of broader macroeconomic shifts like the BOJ's policy pivot.

DAILY MILESTONES TRIGGERED

In afternoon trading, the benchmark 10-year Treasury yield was up 7.7 basis points (bps) at 4.096%, posting its largest one-day increase since roughly mid-July. U.S. 30-year bond yields rose 7.3 bps to 4.744%, the biggest daily increase since July 11.

On the front end of the curve, the two-year yield , which reflects interest rate expectations, rose 4.3 bps to 3.534%, its best daily advance since late October.

Treasury yields did pare their increase after data showed U.S. manufacturing fell for a ninth straight month in November, with factories facing slumping orders and higher prices for inputs as the drag from import tariffs persisted. The Institute for Supply Management said on Monday its manufacturing PMI dropped to 48.2 last month from 48.7 in October. A reading below 50 indicates contraction in manufacturing, which accounts for 10.1% of the economy. "The dire anecdotes from survey respondents indicate that another drop in manufacturing activity is going to come in the near term. However, there is probably some selection bias here," Tom Simons, chief U.S. economist at Jefferies in New York, wrote in a note. "Despite comments to the contrary, we expect that a better climate for business investment, specifically in CAPEX (capital expenditure), will emerge early next year, broadening out the investment push into other areas besides AI compute and electrical grid improvements."

The ISM report boosted expectations that the Federal Reserve will cut interest rates by 25 bps at its December 9-10 policy meeting. That probability was at 85% on Monday, according to LSEG estimates. In other parts of the bond market, the yield curve steepened on Monday, as the spread between U.S. two-year and 10-year yields rose to 56.1 bps, the widest gap in a week, from 51.8 bps on Friday. The curve was last at 55.5 bps. The curve showed a bear-steepening scenario, with long-term yields rising faster than short-term rates, reflecting market concerns about a pickup in inflation. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Joe Bavier and Paul Simao)