Construction spending, meanwhile, neared a four-year high in May, though difficulties in the commercial real estate and factory sector kept recovery in the sector sluggish.

The Institute for Supply Management (ISM) said on Monday its index of national factory activity in June rose to 50.9 from 49.0 in May, a touch above of expectations of 50.5. A reading above 50 indicates expansion in the sector. The gauge for new orders rose to 51.9 from 48.8, while production jumped to 53.4 from 48.6, helping the overall index bounce back from May's contraction — the first in six months.

"It's nice to see manufacturing moving back into growth territory from contraction," said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsylvania.

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But a measure of employment fell to 48.7, the lowest reading since September 2009. It stood at 50.1 in May.

That could feed concern about the strength of the U.S. recovery, particularly now that the Federal Reserve has said it is considering scaling back its massive stimulus program.

"Unfortunately on the employment side, they are not hiring," Naroff said. "That's not a good sign. The employment issue is key. If those jobs are not there, you are not going to get consumer demand."

Growth in the overall manufacturing sector helped U.S. stocks start the third quarter on a positive note, with major indexes rising 1 percent. But the bond market keyed in on the employment component and U.S. Treasuries trimmed earlier losses.

Bradley Holcomb, chairman of the ISM Manufacturing Business Survey Committee, said the decline in hiring breaks "a long, long stream of employment going back to 2009."

But he said "I think it's more a reaction to what has transpired so far this year," adding that "as new orders improve, we would hope to see employment come back into positive territory."

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Elsewhere, construction spending rose 0.5 percent to an annual rate of $847.9 billion in May, the Commerce Department said on Monday.

Economists polled by Reuters last month forecast growth in the broader U.S. economy slowing to a 1.7 percent annual rate in the second quarter, though most say it should pick up steam in the second half.

The government last week cut its growth estimate for the first three months of the year to 1.8 percent from 2.4 percent as consumer spending grew less than initially thought.

Paul Dales, senior U.S. economist at Capital Economics in London, said the fall in factory employment in June would be consistent with declines in manufacturing payrolls of more than 50,000 per month.

"But since this survey has been too pessimistic relative to payrolls for most of the last year, we are sticking to our payrolls forecast of a 150,000 rise in June," he said, which would leave the Fed on track to start winding down bond purchases as soon as September.

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