TREASURIES-US yields decline after tame producer prices

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US producer prices rise 0.2% in December

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US 10-year yield hits 14-month high overnight of 4.8%

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US 2/10 yield curve steepens

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US rate futures price in 30 bps easing or one cut this year

(Adds new comment, graphic, updates prices)

By Gertrude Chavez-Dreyfuss

NEW YORK, Jan 14 (Reuters) - U.S. Treasury yields drifted lower on Tuesday after data showed producer prices increased modestly in December and came in lower than expected, with investors also taking advantage of the drop in prices that led to the recent surge in yields to cover short positions.

The benchmark 10-year yield was down 1.7 basis points (bps) at 4.788% after hitting 4.805% overnight, the highest since November 2023.

On the short-end of the curve, the two-year yield, which is sensitive to rate outlook expectations, fell 3.7 bps to 4.365% . On Monday, it climbed to 4.426%, the strongest level since July.

Data showed that U.S. producer prices rose moderately last month, with the index for final demand gaining 0.2% last month after an unrevised 0.4% advance in November. Economists polled by Reuters had forecast PPI climbing 0.3%.

"The pullback in yields could be due to some consolidation. This has been a pretty fast and furious move up to around 4.80% in the 10-year," said Zachary Griffiths, senior investment grade strategist at CreditSights, in Charlotte, North Carolina.

"If you look at the PPI number, they were a bit better than the forecast (meaning lower inflation). I think that played into it a bit, even though it doesn't have any bearing in terms of the Fed meeting. The Fed is clearly on hold, especially after the payrolls numbers last Friday, and at least for the next couple of meetings."

Investors are now looking to Wednesday's U.S. consumer price index (CPI) report for confirmation about the next move by the Federal Reserve. Wall Street economists are forecasting that the CPI inched up 0.3% in December, unchanged from the previous month, with the year-on-year figure climbing to 2.9% from 2.7% in November, according to a Reuters poll.

The core CPI, meanwhile, is expected to have risen 0.2% in December, down from 0.3% in the prior month.

"From here, we expect that the theme in the Treasury market will be one of consolidation and we're wary of a grind marginally higher in yields in the absence of any other tradable events as we watch for more insight from the incoming administration regarding initial tariff plans," wrote Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets in New York, following the PPI data's release.

Bloomberg News earlier reported that Trump's advisors are in the early stages of planning only a flexible and gradual phase-in of tariffs. Under the proposed plan, U.S. import tariffs would increase in 2-5% increments each month, at the discretion of the President, to try to avoid an inflationary spike.

The U.S. yield curve, meanwhile, steepened on Tuesday, with the spread between two- and 10-year yields touching 42.1 bps . On Monday, the yield curve touched 47.7 bps, the widest gap since May 2022.

The curve typically steepens in an easing cycle as the rise at the short end is restrained, reflecting interest rate cuts.

In the rate futures market, traders on Tuesday fully priced in a rate-cut pause at the Fed's policy meeting later this month. Futures pricing also implied just 30 bps of rate easing in 2025, or one 25-bp cut, LSEG data showed, using the January 2026 fed funds futures. That cut will most likely start again either at the July or September meeting.

Two weeks ago, the rates market had priced in 49 bps in cuts, or about two rate reductions of 25 bps each.

(Reporting by Gertrude Chavez-Dreyfuss; Editing by Angus MacSwan and Nick Zieminski)