Updates yields, adds quotes

By Tatiana Bautzer and Gertrude Chavez-Dreyfuss

NEW YORK, May 15 (Reuters) - U.S. Treasury yields fell sharply on Thursday after data showed deceleration in the world's largest economy in April, including drops in producer prices, manufacturing output, and a slowdown in retail sales.

The reports suggested the Federal Reserve was on track to cut interest rates at least twice this year.

In afternoon trading, the yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB fell 7.9 basis points (bps) to 4.449%, on track for its largest daily drop since April 24.

The yield on the U.S. 30-year Treasury bond also dipped, down 5.2 bps at 4.915% US30YT=RR, after earlier hitting 5% for the first time since April 9.

On the shorter end of the curve, the two-year US2YT=TWEB yield, which typically moves in step with interest rate expectations, was down 9.2 bps at 3.961%, its biggest one-day decline in roughly a month.

Yields retreated after the release of data that showed U.S. producer prices unexpectedly fell in April, with the index for final demand dropping 0.5% after an upwardly revised unchanged reading in March. Economists polled by Reuters had forecast the PPI would rise 0.2%.

"Clearly, companies absorbed a big chunk of tariff increases," Chris Low, chief economist at FHN Financial, said in emailed comments. "Whether they will continue to do so, or will try to pass them on as price increases, remains to be seen."

At the same time, U.S. factory output slid more than expected, down 0.4% last month after an upwardly revised 0.4% gain in March. Economists polled by Reuters had forecast production would slip 0.2% after a previously reported 0.3% rise.

U.S. retail sales, on the other hand, were mixed, with the headline figure edging up 0.1% after an upwardly revised 1.7% jump in March. But core retail sales, which exclude automobiles, gasoline, building materials and food services, fell 0.2% in April after an upwardly revised 0.5% gain in March. This measure corresponds most closely with the consumer spending component of gross domestic product.

"The fall in core retail sales was surprising and is helping push yields down," said Vail Hartman, a rates strategist at BMO Capital Markets in New York. "That's a discouraging start to the second quarter."

Walmart WMT.N, the world's largest retailer, will have to start raising prices later this month due to the high cost of tariffs, executives said on Thursday, as the company declined to provide forecasts for the second quarter. That should further dampen consumer spending and weigh on retail sales even more.

"We are also seeing changes in jobs growth," added Stan Shipley, managing director at ISI. Thursday's unemployment claims report showed requests were stable, but also that job opportunities are becoming more scarce for those out of work as economic uncertainty from tariffs discourages businesses from hiring.

The overall data on Thursday reinforced bets on two interest rate cuts by the Fed, with a roughly 75% chance that the easing would begin in September, according to CME Group's FedWatch tool.

Meanwhile, a closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=TWEB, seen as an indicator of economic expectations, was at 48 bps, little changed from Wednesday's level.

The overall trend remained tilted toward a steeper curve, with yields on the front end falling faster than those on the long end as the Fed carries on with its easing cycle.

(Reporting by Tatiana Bautzer and Gertrude Chavez-Dreyfuss; Editing by Paul Simao and Diane Craft)

((tatiana.bautzer@tr.com; Mob: +1-646-2397968; Reuters Messaging: tatiana.bautzer.thomsonreuters.com@reuters.net/))