TREASURIES-US yields drop after data burst

*

Retail sales unchanged and below expectations

*

Labor costs slightly below estimate

*

Payrolls data due on Wednesday

(Updates to afternoon US trading)

By Chuck Mikolajczak

NEW YORK, Feb 10 (Reuters) - U.S. Treasury yields fell on Tuesday after a round of economic data suggested the economy may be softening, giving the Fed more leeway to cut interest rates. The Commerce Department said retail sales were unchanged in December, below a forecast by economists polled by Reuters for a rise of 0.4%, and below the unrevised 0.6% increase in November.

A ?separate report from the Labor Department showed the Employment Cost Index (ECI), the broadest measure of labor costs, rose 0.7% in the fourth quarter after advancing 0.8% in the July-September quarter and below the ?estimate for a 0.8% rise as demand for labor has waned.

"At the headline level, the market's getting excited, or at least what's supporting ?the bond market is that the weak retail sales are suggesting that maybe the growth, blistering growth that ?we've seen, is fading a ?little bit," said Thomas Urano, co-chief investment officer at Sage Advisory in Austin.

"The weather's definitely had an impact here but if you put the retail sales number along with the commentary ?from (White House economic adviser Kevin) Hassett yesterday, which is, 'hey, guys, be prepared for some ?weaker labor numbers coming in the reporting cycle,' it's pouring a little bit of cold water on growth expectations on the economy."

Hassett said on Monday that U.S. job gains could be lower in the coming months due to slower ?labor force growth and higher productivity, a factor that is likely to ?impact the Fed's ?policy decisions. Market expectations for a cut from the Fed edged up after the data, although June remains the first month pricing in more than a 50% chance of a cut, according to CME's FedWatch Tool. The yield on the benchmark U.S. 10-year Treasury ?note fell 5.1 basis points to 4.147%, on track for its fourth straight day of declines. The yield has dropped more than 13 basis points over that timeframe, its biggest four-day drop since mid-October. Other data from the Labor Department on Tuesday said U.S. import prices were unchanged on a year-on-year basis in December after falling 0.1% in November.

Among other key data due this week, the Consumer Price Index (CPI) for January is scheduled for Friday, and the nonfarm payrolls report for January, which was delayed due to a brief U.S. government shutdown that ended last week, is due ?on Wednesday. The yield on ?the 30-year bond declined 6.1 basis points to 4.788% and was on pace for its biggest daily drop since October 10. Federal Reserve Bank of Cleveland President Beth Hammack said it is important to get to 2% inflation before changing interest rates again, ?while Dallas Federal Reserve President Lorie Logan said she's "cautiously optimistic" that the Fed's current policy rate setting will get inflation headed to its 2% goal while keeping the job market stable.

The two-year U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, dipped 2.5 basis points to 3.458%.

An auction of $58 billion in three-year notes was seen as solid by analysts, with demand of 2.62 times the notes on sale slightly below the 2.68 average, according to analysts at BMO Capital Markets.

More supply will come to the market this week as the Treasury auctions $42 billion in 10-year notes on Wednesday and $25 billion in 30-year bonds ?on Thursday.

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 positive 68.7 basis points. The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) was last at 2.488% after closing at 2.52% on February 9. The 10-year TIPS breakeven rate was last ?at 2.314%, indicating the market sees inflation averaging about 2.3% a year for the next decade.

(Reporting by Chuck Mikolajczak; Editing by Susan Fenton and Nick Zieminski)