TREASURIES-US yields climb as inflation amps up rate-hike bets, oil soars 

Updates to late afternoon

By Sinéad Carew and Karen Brettell

Sept 10 (Reuters) - U.S. Treasury yields climbed on Thursday after the latest inflation reading pushed up expectations for a Federal Reserve interest rate hike next week, while soaring oil prices exacerbated inflation worries.

Yields also extended their increase after the U.S. government said it bought back $5.2 billion worth of bonds in its latest buyback operation meant to support market liquidity, less than the $6 billion cap and only half of the $10.5 billion in bonds offered in the operation.

Yields on 10-year Treasury notes traded at their highest levels since late 2023 while 30-year Treasury yields hit their highest levels since 2007 and 2-year Treasury yields reached their highest levels in more than two years.

Longer-dated yields pared gains after a successful government auction of 30-year bonds but the move was short-lived as oil futures extended their rally.

Earlier on Thursday, data showed the U.S. producer price index (PPI) increased in line with expectations on a monthly basis. But in the 12 months through August, it advanced 5.4% compared with consensus expectations for 5.3% and a 4.8% increase in July. Energy prices increased 4.2% in August after declining for two straight months.

After the data, traders were betting on a roughly 70% chance the Fed would raise rates by 25 basis points at its September 15 to 16 meeting, up from 62% earlier, according to LSEG's interest rate probabilities data.

"Going into PPI, we were driven largely by oil prices surging overnight. The PPI headline came in at consensus, but some of the components that feed into core PCE came in a little bit stronger than markets were expecting," said Molly Brooks, U.S. rates strategist at TD Securities.

Brooks said that personal consumption expenditures (PCE), a measure closely watched by the Fed, could be pushed up by rising prices in segments such as airfares.

Chris Osmond, chief investment officer for Fifth Third Wealth Advisors, said the market appeared focused on the sharp acceleration in the year-over-year rate and hot components such as airfares and hospital care along with upward revisions to July.

"Combined with elevated oil prices and a live Fed meeting next week, investors perceived this print as inflationary rather than disinflationary; hence yields moved higher, equities moved lower, and rate-hike odds firmed," Osmond wrote in a research note.

Adding to inflation worries was a roughly 6% rally in oil prices with both benchmarks trading over $100 as the biggest spike in attacks on shipping since the Iran war began fed worries among traders about further disruptions to already tight energy supplies. This came after President Donald Trump said he expected the Iran war to end after November's midterm elections.

The yield on benchmark U.S. 10-year notes rose 10.93 basis points to 4.946%, hitting its highest levels since October 2023.

The 30-year bond yield rose 7.27 basis points to 5.3587%, reaching its highest point since June 2007.

The 2-year note yield, which typically moves in step with interest rate expectations for the Federal Reserve, rose 13.33 basis points to 4.56%, touching its highest point since July 2024.

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 38.4 basis points after reaching its flattest point since July 29.

The August consumer price index report, due out Friday, will be the next big test for inflation expectations.

Meanwhile, the government saw very strong demand for a $22 billion sale of 30-year bonds on Thursday. The debt sold at a high yield of 5.308%, more than 2 basis points below where it traded before the auction. The bid-to-cover ratio was 2.61 times, its highest since February.

Lou Brien, a market strategist at DRW Trading, described Thursday's auction as "exceptional," noting that there appeared to be strong demand from overseas buyers.

This was after Wednesday's government auction of $39 billion in 10-year notes had also met strong demand.

Earlier, the European Central Bank raised interest rates for the second time this year in a widely flagged move on Thursday, hoping to tame inflation driven by higher energy costs from the Iran war.

(Reporting by Sinead Carew, Karen Brettell, Chuck Mikolajczak, editing by Deepa Babington and Nick Zieminski)

((sinead.carew@thomsonreuters.com))