*

ISM manufacturing PMI rose to 47.2 in Aug, still

indicating

contraction

*

Fed expected to cut rates by at least 25 bps at September

meeting

*

Two-year Treasury yield fell 6.2 bps, biggest drop since

August

23

(Updated at 2:33 p.m. ET/1833 GMT)

By Chuck Mikolajczak

NEW YORK, Sept 3 (Reuters) - U.S. Treasury yields fell

on Tuesday, with the benchmark 10-year note set to break a

five-session streak of gains, after data signaled activity in

the manufacturing sector remains soft.

The Institute for Supply Management (ISM) said its

manufacturing PMI rose to 47.2 in August from an eight-month low

of 46.8 in July, and remained below the 50 reading to indicate

contraction for the fifth straight month.

"The bounce in manufacturing from July's abysmal reading

wasn't all that great. New orders dropped, which doesn't augur

well for a future rebound in activity," said Brian Jacobsen,

chief economist at Annex Wealth Management in Menomonee Falls,

Wisconsin.

"The Fed cares about the labor market, not the manufacturing

sector. It will take service sector weakness to scare the Fed

into doing more than a 25 basis point cut and that just doesn't

seem to be in the cards for now."

Investors will get a host of data on the labor market this

week, culminating in Friday's key government payrolls report.

The yield on the benchmark U.S. 10-year Treasury note

fell 5.7 basis points (bps) to 3.854%. The yield

snapped a two-week streak of declines last week as economic data

boosted expectations the Fed was more likely to opt for a

smaller cut of 25 basis points at its Sept. 18 policy

announcement.

Markets have fully priced in a rate cut of at least 25 bps

at the upcoming meeting, with expectations for a cut of 50 bps

climbing to 37% after the data, up from 30% in the prior

session, according to CME's FedWatch Tool.

The yield on the 30-year bond fell 5.3 basis

points to 4.143%.

Recent comments from Fed policymakers signal the majority

are ready to support a rate cut by the central bank at its

September meeting.

A closely watched part of the U.S. Treasury yield curve

measuring the gap between yields on two- and 10-year Treasury

notes, seen as an indicator of economic

expectations, was at a negative 3.8 basis points.

The two-year U.S. Treasury yield, which typically

moves in step with interest rate expectations, fell 3.7 basis

points to 3.865%, on track for its biggest daily drop since Aug.

23.

The breakeven rate on five-year U.S. Treasury

Inflation-Protected Securities (TIPS) was last at

1.984% after closing at 2.034% on August 30.

The 10-year TIPS breakeven rate was last at

2.112%, indicating the market sees inflation averaging about

2.1% a year for the next decade.