(Recasts with Fed meeting minutes, adds analyst quotes, data, updates prices) By Karen Brettell NEW YORK, July 6 (Reuters) - Benchmark U.S. Treasury yields edged higher on Wednesday but had a relatively muted reaction after minutes from the Federal Reserve's June meeting showed that a deteriorating inflation situation prompted Fed officials to rally around an outsized interest rate increase. Based on data released in the days prior to the session, "participants concurred ... that the near-term inflation outlook had deteriorated since the time of the May meeting," the minutes stated, justifying the 0.75-percentage-point increase and a move to "restrictive" monetary policy. The Fed made the hike, the largest in more than a quarter of a century, following data that showed inflation rising more quickly than expected in May. "People are concerned that inflationary expectations are becoming entrenched," said David Petrosinelli, senior trader at InspereX, adding that the Fed communication prepared the market for the minutes. Yields soared in the run-up to the June 14-15 meeting as investors prepared for an aggressive rate hike before dropping sharply as markets adjusted for the prospect of an economic downturn as a result of the Fed's monetary tightening. "The macro narrative has shifted from inflation to growth and it's very topical that there's the risk of a recession in the next 12 months," said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets in New York. Traders increased expectations on how high the U.S. central bank will raise its benchmark rate after the minutes, though they remain lower than before the meeting as concerns about an economic downturn increase. "That's concerns about inflation and concerns that we're going to have a period of much slower growth and a more aggressive Fed," Petrosinelli said. Fed funds futures traders are pricing for the Fed's benchmark rate to peak at 3.40% in March, compared with pricing Wednesday morning for a top of around 3.25% in February. Expectations before the June meeting were that it would increase to around 4% by May. It is currently 1.58%. The two-year, 10-year part of the Treasury yield curve reached minus 7 basis points, after inverting on Tuesday for the first time in three weeks, a move that is seen as a reliable indicator that a recession will follow in one to two years. The two-year, five-year part of the curve also reached minus 5 basis points after inverting on Tuesday for the first time since February 2020. Benchmark 10-year yields were last at 2.919% after earlier dropping to 2.746%, the lowest since May 27. They have fallen from 3.498% on June 14, the highest since April 2011. The 10-year yields have closed a gap from late May, when yields began to spike. A drop below the 2.70% area, just below May's low of 2.706%, could open the door to further declines to the 2.50% area, Lyngen said. Two-year Treasury yields were at 2.583% and are down from 3.456% on June 14, which was the highest since November 2007. Inflation expectations gained ground after the minutes, with breakeven rates on five-year Treasury Inflation-Protected Securities (TIPS), a measure of expected annual inflation for the next five years, last at 2.50%. They earlier fell to 2.49%, the lowest since November 2021. < USBEI5Y=RR> The next major U.S. economic release will be Friday's jobs report for June. Economists polled by Reuters expect employers to have added 268,000 jobs during the month. Data on Wednesday showed that U.S. job openings fell less than expected in May. The U.S. services industry also slowed less than expected in June, though a measure of services employment dropped to a two-year low, suggesting that demand for labor could be ebbing. July 6 Wednesday 3:06PM New York / 1906 GMT Price Current Net Yield % Change (bps) Three-month bills 1.85 1.8845 -0.007 Six-month bills 2.515 2.5828 0.026 Two-year note 100-13/256 2.9732 0.157 Three-year note 99-174/256 2.9892 0.170 Five-year note 101-86/256 2.9595 0.143 Seven-year note 101-172/256 2.9829 0.124 10-year note 99-160/256 2.9188 0.108 20-year bond 97-168/256 3.4133 0.115 30-year bond 95-56/256 3.1223 0.089 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 26.00 -1.00 spread U.S. 3-year dollar swap 9.50 -0.75 spread U.S. 5-year dollar swap 3.00 0.00 spread U.S. 10-year dollar swap 7.75 0.25 spread U.S. 30-year dollar swap -26.75 -2.25 spread (Reporting by Karen Brettell; Editing by Barbara Lewis and Will Dunham)
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