TREASURIES-Two-year yields rise before Tuesday's US consumer price report

By Karen Brettell

Aug 11 (Reuters) - Benchmark 10-year U.S. Treasury yields edged lower while interest rate sensitive two-year yields were the highest in a week on Monday before Tuesday’s highly anticipated consumer price inflation report for July.

Yields tumbled after jobs data for July showed that employers added fewer jobs than expected last month, while job gains for previous months were also revised sharply lower.

Traders are now pricing in 88% odds that the Federal Reserve will cut rates at its next meeting in September, but the prospect of a renewed uptick in inflation is seen complicating the interest-rate outlook.

Fed Chair Jerome Powell has said that he anticipates prices to rise this summer as a result of President Donald Trump’s tariff policies.

A weakening consumer, however, would likely dent inflation increases, said Thomas Simons, chief U.S. economist at Jefferies in New York.

“I don't understand how we can have this mentality that the consumer is completely tapped out and not able to continue to drive growth, but at the same time that pricing power is going to be maintained on both the goods and services side,” Simons said.

“My view is more that if we do have tariff-driven inflation that pushes goods prices up, that's going to reduce demand for something else, whether that's other goods or services. And thus, the pricing power is going to be weakened, and we'll see some offsetting declines in prices that limits the overall inflation pressure,” he added.

Economists polled by Reuters expect Tuesday’s inflation report to show that headline inflation rose by 0.2% last month for an annual gain of 2.8%, while core prices rose by 0.3% for an annual increase of 3.0%. USCPI=ECI, USCPNY=ECI, USCPF=ECI, USCPFY=ECI

The yield on benchmark U.S. 10-year notes US10YT=RR was last down 1 basis points on the day at 4.273%.

The 2-year note US2YT=RR yield rose 0.8 basis point to 3.766%.

The yield curve between two-year and 10-year notes flattened by around one basis point to 51 basis points. US2US10=TWEB

Traders are also focused on talks for a potential peace deal between Russia and Ukraine.

Ukrainian President Volodymyr Zelenskiy won diplomatic backing from Europe and the NATO alliance on Sunday ahead of a Russia-U.S. summit this week where Kyiv fears President Vladimir Putin and President Donald Trump may try to dictate terms for ending the 3-1/2-year war.