TREASURIES-US 10-year yield rallies from 16-month low after strong retail sales

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U.S. 10-year yield hits lowest since May 2023

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August retail sales surprise to upside

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U.S. 2/10 curve flattens to 3.5 bps

By Matt Tracy

WASHINGTON, Sept 17 (Reuters) - U.S. Treasury 10-year yields rose from 16-month lows on Tuesday after retail sales in the world's largest economy increased unexpectedly last month, suggesting there is no urgency for the Federal Reserve to do a supersized rate cut of 50 basis points on Wednesday.

The Fed is widely expected to cut interest rates following a two-day meeting starting on Tuesday. The size of the rate reduction, however, is still very much up in the air.

Following the retail sales data, benchmark 10-year Treasury yields fell to 3.599%, their lowest since May 2023, but rallied to trade 1.9 bps higher at 3.641%. On the short end of the curve, the two-year yield rose after hitting its weakest level in two years on Monday. It was last up 4.6 bps at 3.60%.

U.S. retail sales surprisingly increased 0.1% in August, after an upwardly revised 1.1% surge in July. Economists polled by Reuters had forecast retail sales falling 0.2% last month.

After the report, U.S. rate futures still priced in a 61% chance of a 50-bp easing on Wednesday, with a 39% probability of the standard 25 bps move, LSEG estimates showed. Futures traders have also factored in about 120 bps in cuts this year and 245 bps through September next year.

The yield on the 30-year bond was last flat at 3.931% after earlier dropping to its lowest since July 2023 at 3.898%. "We're not seeing anything significant. I still think it's kind of a wait-and-see," said Tom di Galoma, head of fixed income trading at Curvature Securities.

"I think people are really very unsure what the Fed's going to do here, so I don't think we're going to see very much happening until two o'clock tomorrow," he said.

Most economists expect the U.S. central bank to cut rates by 25 bps on Wednesday, according to a Reuters poll, arguing that the economy is not in distress to warrant the half-percentage-point reduction being anticipated by financial markets.

The U.S. yield curve flattened after the data, with the yield spread between two- and 10-year notes narrowing to 3.5 bps , compared with 6.5 bps late on Monday. The slight flattening of the curve suggested the market has modestly reduced rate cut expectations.

Also on Tuesday, the U.S. Treasury Department is scheduled to auction $13 billion in 20-year notes. (Reporting by Matt Tracy; Editing by Gertrude Chavez-Dreyfuss and Jonathan Oatis)