Adds new comment, graphic, US 10-year note auction results, updates prices

By Gertrude Chavez-Dreyfuss

NEW YORK, Feb 12 (Reuters) - U.S. Treasury yields bounced on Wednesday after inflation in the world's largest economy came in stronger than expected last month, reinforcing expectations that the Federal Reserve is likely to pause its rate-cutting cycle for an extended period.

U.S. yields also held gains after a lackluster 10-year note sale that saw soft demand, which was not a surprise given that past auctions, more often than not, came in weaker than expected.

In afternoon trading, the benchmark 10-year yield rose 9.6 basis points (bps) to 4.635% US10YT=RR after earlier hitting a roughly three-week high of 4.66%. The yield posted its largest daily rise in roughly two months.

U.S. 30-year yields also gained sharply, up 10.3 bps at 4.851% US30YT=RR, on pace for the largest daily gain since around mid-November.

On the front end of the curve, the two-year yield, which reflects policy moves by the Fed, climbed 7.5 bps to 4.370% US2YT=RR, its biggest daily gain since January 10. Earlier in the session, it hit its highest since mid-January of 4.389%.

Data showed that the consumer price index $(CPI.UK)$ gained 0.5%, exceeding consensus estimates for a 0.3% increase, and posting the biggest monthly advance since August 2023. On a year-on-year basis, CPI rose 3% in January compared with the 2.9% increase expected by economists polled by Reuters.

"It was a disappointing development for the bond market and for the Fed itself. What this does, combined with the (strong) employment report, is just keeps the argument for the Fed to sit and wait," said Kevin Flanagan, head of fixed income strategy at WisdomTree in New York.

"They already cut rates by 100 basis points. It's not as if there's an urgency to cut. The economic numbers are not providing any urgency for the Fed to go."

Following the data, the U.S. rate futures market priced in just 27 bps of easing this year or one rate cut, with the next rate reduction pushed back either to the October or December meeting, according to LSEG calculations. Futures traders had for many weeks priced in a likely easing in June.

Fed Chair Jerome Powell, meanwhile, testified on Wednesday for a second day, appearing before the House Financial Services Committee, repeating the same opening statement delivered in a hearing before the Senate Banking Committee the day before. His comments during a question-and-answer session with House lawmakers drew little market reaction.

TARIFF WOES

While the prospect of tariffs loomed on the horizon, Mike Sanders, head of fixed income at Madison Investments in Madison, Wisconsin, viewed them as having a one-time upward impact on consumer prices, with the rate of change probably remaining the same.

"A real concern would be the retaliatory tariffs and what they do for jobs, in terms of slowing down the labor market," said Sanders of Madison, which oversees $25 billion in assets. "That's when you will see the slowdown occur."

President Donald Trump's trade advisers finalized plans on Wednesday for reciprocal tariffs the U.S. president has vowed to impose on every country that charges duties on U.S. imports, escalating worries of a global trade war and threatening to add to already-sticky U.S. inflation.

Also on Wednesday, the U.S. Treasury's auction of $42 billion in 10-year notes was not strongly received. The note was priced at a high yield of 4.632%, about a basis point higher than the expected rate at the bid deadline, suggesting that investors demanded a premium to buy the 10-year note.

The bid-to-cover ratio, another measure of demand, was 2.48, down from the 2.53 average and also the cover seen in the January auction.

On Tuesday, the Treasury's $58 billion three-year note sale was described by many market participants as "stellar."

J.P. Morgan, however, pointed out in a research note that over the last two years, six 10-year auctions had taken place on days CPI data was released, with an average tail - the level by which the rate was higher than the rate forecast - of 1.0 bp. On the 18 non-CPI day auctions, the average tail was only 0.4 bp.

In other parts of the bond market, the yield curve steepened, with the spread between two-year and 10-year yields at 26.8 bps US2US1O=TWEB, compared with 24.5 bps late Tuesday.

Investors continued to sell the long end of the curve more than the front end, resulting in higher yields for the former, reflecting concerns about inflation down the road along with policy uncertainty under the Trump administration.

(Reporting by Gertrude Chavez-Dreyfuss; Editing by Christina Fincher, Jane Merriman, Peter Graff and Andrea Ricci)

((gertrude.chavez@thomsonreuters.com; 646-301-4124))