Updates to afternoon trading

By Chuck Mikolajczak

NEW YORK, July 14 (Reuters) - U.S. Treasury yields declined on Tuesday after data showed consumer inflation slowed more than expected in June, dampening market expectations for a near-term rate hike from the Federal Reserve.

The Labor Department said the Consumer Price Index increased 3.5% in the 12 months through June after surging 4.2% in May, the largest year-on-year rise since April 2023. On a monthly basis, CPI fell 0.4% after a 0.5% increase in May. Economists polled by Reuters had forecast the CPI would rise 3.8% on a year-over-year basis and dip 0.1% on a monthly basis.

“This (report) is a bit of a surprise. And obviously, it all reflects one thing, the fall in energy prices," said Peter Cardillo, chief market economist at Spartan Capital Securities in New York.

"This should help relieve some worries in the bond market, and it should give some wiggling room for the Fed.”

Yields pared declines however, as Federal Reserve Chairman Kevin Warsh gave testimony to the House Financial Services Committee and said today's data does not mean the central bank has satisfied its price stability mandate.

The yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB fell 3.1 basis points, on pace for its biggest daily drop since June 24, to 4.579%, after falling to 4.525%.

OIL CLIMBS AS MIDDLE EAST HOSTILITIES RISE

Energy prices have come down in recent weeks on expectations that a durable peace deal could be reached between the U.S. and Iran. However, hostilities have intensified in recent days and caused a reversal in crude prices.

U.S. crude CLc1 rose 0.96% to $78.90 a barrel and Brent LCOc1 advanced to $84.27 per barrel, up 1.16% on the day.

The two benchmarks touched four-week highs after the U.S. reimposed a naval blockade of Iran and as renewed attacks between Washington and Tehran exacerbated supply concerns but pared gains after U.S. President Donald Trump backed off his recent announcement to charge a 20% fee to guard the Strait of Hormuz.

The yield on the 30-year bond US30YT=TWEB dipped 1 basis point to 5.088% after dropping to 5.051%.

FED RATE HIKE EXPECTATIONS TUMBLE

Expectations for a rate hike of at least 25 basis points from the Fed at its July meeting tumbled to 16.6% from 41.7% in the prior session, according to CME Group's FedWatch tool. For the central bank's September meeting, markets are pricing in a 59.8% chance of a hike, down from 75.1% on Monday.

"This was a very encouraging inflation report that should tamp down what seemed to be a growing chorus of folks looking for them to hike at the July meeting," said Tom Porcelli, chief economist at Wells Fargo, in a note.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=TWEB, seen as an indicator of economic expectations, was at a positive 37.9 basis points.

Several Fed officials have in recent weeks flagged concerns about inflation pressures while playing down any labor market worries. Chicago Federal Reserve President Austan Goolsbee said Tuesday's data was "surprisingly benign" and "encouraging" but that one month's data is not enough to convince him inflation is headed back to 2%.

Barclays U.S. economist Pooja Sriram said in a note that the data "likely buy time for the FOMC to remain on hold and wait for additional data," and maintained the firm's call for the Fed to keep rates unchanged for the rest of the year.

The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, tumbled 5.7 basis points to 4.206% after dropping to 4.147%, and was on track for its biggest daily decline since June 11.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) US5YTIP=TWEB was last at 2.282% after closing at 2.329% on Monday.

The 10-year TIPS breakeven rate US10YTIP=TWEB was last at 2.256%, indicating the market sees inflation averaging about 2.3% a year for the next decade.