* Unexpected rise in retail sales adds to inflation fears * Five-year breakeven inflation rate highest since April 2005 (Adds comment, new prices) 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 rose 4.9 basis points to 1.569% amid fears that supply constraints could disrupt the holiday shopping season amid continued shortages of motor vehicles and other goods. 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) was last at 2.727% after earlier hitting 2.753%, the highest since April 2005. 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 was up 2.7 basis points to 2.052%. A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at 117.6 basis points. The two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, was up 3.7 basis points at 0.391%. The 10-year TIPS breakeven rate was last at 2.556%, 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 , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's bond buying, was last at 2.553%. Oct. 15 Friday 1:32PM New York / 1732 GMT Price Current Net Yield % Change (bps) Three-month bills 0.0475 0.0482 0.002 Six-month bills 0.0575 0.0583 0.000 Two-year note 99-186/256 0.3908 0.037 Three-year note 99-216/256 0.6778 0.048 Five-year note 98-228/256 1.1059 0.056 Seven-year note 99-4/256 1.3991 0.055 10-year note 97-28/256 1.5685 0.049 20-year bond 95-176/256 2.0149 0.037 30-year bond 98-216/256 2.052 0.027 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 14.00 0.50 spread U.S. 3-year dollar swap 14.75 0.25 spread U.S. 5-year dollar swap 7.25 -0.25 spread U.S. 10-year dollar swap 0.75 -0.50 spread U.S. 30-year dollar swap -23.50 1.00 spread (Reporting by Herbert Lash; Editing by Alison Williams and Diane Craft)
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