U.S. yields rise on bearish rates outlook

* Unexpected rise in retail sales adds to inflation fears

* Five-year breakeven inflation rate highest since April 2005

By Herbert Lash

NEW YORK, Oct 15 (Reuters) - Treasury yields rose and a market indication of inflation expectations hit the highest since 2005 on Friday as an unexpected increase in U.S. retail sales in September added to bearish bond sentiment about the path of interest rates.

The yield on benchmark 10-year U.S. Treasury notes US10YT=RR rose 5.5 basis points to 1.574% amid fears that supply constraints, as seen in shortages of motor vehicles and other goods, could disrupt the holiday shopping season.

Retail sales rose 0.7% last month and data for August was revised higher to show retail sales increased 0.9% instead of 0.7% as initially reported by the Commerce Department.

September sales were partly lifted by higher prices.

"There's an overwhelming bearishness in the market from a lot of the hedge funds and big macro accounts that think rates are going to go up another 50 basis points by year-end or early next year," said Tom di Galoma, a managing director at Seaport Global Holdings in Greenwich, Connecticut.

The Federal Reserve will likely begin to taper its massive bond purchases in December but will hold off on increasing the federal funds rate for the moment, di Galoma said.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) US5YTIP=RR was last at 2.735% after earlier hitting 2.753%, the highest since April 2005.

The two-year U.S. Treasury yield rose to 0.403%, its highest since March 2020, suggesting investors are pricing in a more aggressive rate hike by the Fed than previously expected.

The Fed's insistence that higher consumer prices is transitory has been thoroughly debunked by now, said David Petrosinelli, senior trader at InspereX.

"The gorilla has been in the room for a long time, but maybe the gorilla was a little too quiet," Petrosinelli said about inflation. "Now people realize there’s a gorilla in the room."

The cost of buying a home and more recently, surging U.S. rental prices, are clear signs of rising inflation, not to mention higher gasoline prices, he said.

"If people believe there's inflation, that's when inflation is self-fulfilling," Petrosinelli said.

Investors are looking to next week's auction of $24 billion in 20-year bonds and $19 billion in five-year TIPS that the Treasury announced on Thursday.

The yield on the 30-year Treasury bond US30YT=RR was up 2.1 basis points to 2.046%.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=RR , seen as an indicator of economic expectations, was at 117.7 basis points.

The 10-year TIPS breakeven rate US10YTIP=RR was last at 2.562%, indicating the market sees inflation averaging almost 2.6% a year for the next decade.

The U.S. dollar 5-year forward inflation-linked swap USIL5YF5Y=R , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's bond buying, was last at 2.560%.

Oct. 15 Friday 4:10PM New York / 2010 GMT


Current Net

Yield % Change

(bps) Three-month bills US3MT=RR 0.0525


0.007 Six-month bills US6MT=RR



0.000 Two-year note US2YT=RR

99-184/256 0.3949

0.041 Three-year note US3YT=RR

99-206/256 0.6911

0.061 Five-year note US5YT=RR

98-208/256 1.1222

0.072 Seven-year note US7YT=RR

98-244/256 1.4086

0.065 10-year note US10YT=RR



0.055 20-year bond US20YT=RR

95-184/256 2.0129

0.035 30-year bond US30YT=RR

98-248/256 2.0463



Last (bps) Net



U.S. 2-year dollar swap




U.S. 3-year dollar swap




U.S. 5-year dollar swap




U.S. 10-year dollar swap




U.S. 30-year dollar swap




Reporting by Herbert Lash; additional reporting by Gertrude Chavez-Dreyfuss in New York and Karen Pierog in Chicago; Editing by Alison Williams, Diane Craft and Cynthia Osterman

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