TREASURIES-Longer-dated US yields dip, Fed's rate outlook in focus

By Karen Brettell

June 17 (Reuters) - U.S. Treasury yields fell on Tuesday, a day before the Federal Reserve is due to update its economic and interest rate projections, with data on Tuesday showing a drop in retail spending last month.

Market moves were largely subdued with benchmark 10-year yields holding in the middle of their recent range as investors await the next catalyst to drive direction.

The yields US10YT=RR were last down 2 basis points on the day at 4.432%. They have held between a low of 4.124% and a high of 4.629% since May 1.

The Fed is expected to hold rates steady on Wednesday as Fed officials wait to see the impact on the economy of the Trump administration’s tariff policies. Policymakers have expressed concerns that the trade levies will slow growth and increase inflation.

"The Fed and (Chair Jerome) Powell have talked a lot about pressure on both sides of the dual mandate, where the risks to a sharper slowdown in the labor market have grown but at the same time the risks to higher inflation have also grown,” said Mike Medeiros, macro strategist at Wellington Management in Boston.

With inflation already elevated and the impact of tariffs still to come, the Fed may be more likely to maintain projections for 50 basis points in cuts for this year, or reduce them to one 25 basis point cut, than it would be to increase its forecast to 75 basis points, Medeiros said.

Fed funds futures traders are pricing in 46 basis points of cuts by year-end, indicating they see two 25 basis point reductions as most likely.

Market reaction was subdued to data showing that U.S. retail sales dropped more than expected in May with a 0.9% decline. U.S. import prices were unchanged in May amid lower costs for energy products.

Meanwhile Treasuries may have been boosted by some safety buying as geopolitical tensions in the Middle East increase.

U.S. President Donald Trump said he wanted a "real end" to the nuclear dispute with Iran and indicated he may send senior American officials to meet with the Islamic Republic as the Israel-Iran air war raged for a fifth day.

The Bank of Japan kept interest rates steady on Tuesday and decided to decelerate the pace of its balance sheet drawdown next year, signaling its preference to move cautiously in removing remnants of its massive, decade-long stimulus.

Traders are also focused on a tax and spending bill in U.S. Congress, which is likely to provide some short-term economic stimulus but also increase the U.S. debt load over the coming decade.

The fiscal impact of the bill could offset some of the growth hit from tariffs, though it could also result in higher for longer inflation, said Medeiros.

"If you're going to constrain the supply side of the economy through tariffs and immigration restrictions and then boost short-term demand through fiscal policy, then that would increase the probability that inflation is actually sustained a bit higher for a bit longer and I don't think that's necessarily in the price right now," Medeiros said.

U.S. Senate Republicans on Monday unveiled proposed changes to the sweeping bill that would make some business-related tax breaks permanent while making more limited the deduction for state and local income taxes, angering some colleagues in the House of Representatives.

The Treasury Department, meanwhile, will sell $23 billion in five-year Treasury Inflation-Protected Securities on Tuesday.

The yield on the interest rate-sensitive 2-year note US2YT=RR rose 0.2 basis points to 3.969%.

The yield curve between two-year and 10-year notes US2US10=TWEB flattened by around 2 basis points to 46 basis points.