TREASURIES-US yields steady with gradual start to rate cuts in view

(Updates at 1500 ET)

By Davide Barbuscia

NEW YORK, Sept 12 (Reuters) - U.S. Treasury yields rose on Thursday as economic data did not upend expectations the Federal Reserve will begin a gradual decrease in interest rates next week, and as the European Central Bank cut rates but gave little clarity on future easing.

U.S. producer prices increased slightly more than expected in August, but the trend remained consistent with subsiding inflation. On the labor market side, meanwhile, data on Thursday showed the number of Americans filing new applications for unemployment benefits increased marginally last week.

The data did not significantly alter investor expectations of a 25-basis-point interest rate cut by the U.S. central bank at its Sept. 17 to 18 rate-setting meeting. Bets for a bigger, half-percentage point cut were curbed on Wednesday when consumer price data showed inflation remains somewhat sticky.

"The initial (jobless) claims were benign as far as any relationship to movement in bond prices," said Lou Brien, market strategist at DRW Trading in Chicago.

Traders in rates futures were assigning a 29% chance to a 50-bps cut next week, more than on Wednesday, with the consensus remaining largely on a 25-bps reduction adjustment, CME Group data showed.

"The market has been expecting the Fed to move next week and they're likely to move," said Erik Aarts, senior fixed income strategist at Touchstone Investments. "Some in the marketplace thought there could be a larger cut next week; we don't think so, we're firmly in the camp of getting 25 basis point as the start of rate cuts," he said.

U.S. bond giant PIMCO said in a note on Thursday it expects the Fed to cut rates by 25 basis points three times this year, as resilience in the U.S. economy points to a gradual descent to a less restrictive policy.

Meanwhile on Thursday the European Central Bank cut its deposit rate by 25 bps to 3.50%, as expected, following a similar cut in June. But bets on ECB rate cuts for the rest of the year were pared back, leading to higher euro zone government bond yields.

This likely helped push U.S. yields higher, said Lawrence Gillum, chief fixed income strategist at LPL Financial.

"We also think there's been a lot of rate cuts priced into the US markets already, and we think the Fed is going cut rates only 25 basis point next week ... so rates are probably going to trend higher into the Fed meeting," he added.

WEAK AUCTION

On the supply side, a $22 billion 30-year Treasury bond auction on Thursday met lukewarm demand. The bonds were sold at a high yield of 4.015%, about one and a half basis point above the market at the bidding deadline.

This came after

U.S. budget deficit

data released by the Treasury Department showing the fiscal 2024 deficit through August was up 24% from a $1.525 trillion deficit in the comparable year-ago period, with annual interest costs on the public debt topping $1 trillion for the first time.

"The 30-year was a weak auction but it's possible we start to see a string of weak auctions given the amount of Treasury debt that has to come to market to fill these budget deficits," said Gillum.

Benchmark 10-year Treasury yields added nearly three basis points to 3.681%. Two-year yields, which tend to more closely reflect expectations of changes in monetary policy, were last at 3.649%, a touch higher than on Wednesday.

On the long end, 30-year yields rose by three basis points to about 4%.

The curve comparing 10- and two-year yields, closely watched by investors for its signals on the economic outlook, steepened to three basis points from less than one on Wednesday.

(Reporting by Davide Barbuscia; Editing by Emelia Sithole-Matarise and Diane Craft)