Updated in New York morning time

By Karen Brettell

May 21 (Reuters) - Longer-dated U.S. Treasury yields rose on Wednesday as investors continued to monitor the progress of a tax bill in the U.S. Congress and ahead of a Treasury Department auction of 20-year bonds.

A deteriorating fiscal outlook has taken focus this week after Moody's Investors Service on Friday cut the United States’ sovereign credit rating from the top "Aaa".

"This is the first auction since the downgrade and then you've got a lot of uncertainty about the tax bill," said Tom di Galoma, managing director at Mischler Financial Group.

"People are somewhat confused about who will participate, how they'll participate and will the bids be more defensive" in the auction, he added.

Yields at the longer end of the Treasury curve have been rising steadily this month, driven by domestic fiscal concerns and worries that President Donald Trump's erratic economic policies will not only stoke inflationary pressures but also erode the appeal of U.S. assets. Yields in Japan and the euro zone have risen too this week.

Some investors are concerned that the tax and spending bill has fewer spending cuts than previously hoped.

The bill faces a critical stress test on Wednesday as Republicans in the U.S. House of Representatives try to overcome internal divisions over cuts to the Medicaid health program and tax breaks in high-cost coastal states.

Longer-dated yield increases have been due to "a combination of concern over inflation and fiscal" issues, with easier tax policies being a newer factor in recent days, said Stephen Gola, head of U.S. Treasuries Sales & Trading at StoneX Group.

Gola noted that hedge funds have been putting on steepener trades, or bets that longer-dated yields will rise relative to shorter-dated ones, which could be having an outsized impact on market moves.

Foreign demand for a $16 billion sale of 20-year bonds will be a focus on Wednesday as investors watch for any signs that the worsening U.S. fiscal picture or Trump's trade policies are denting foreign investment in the United States.

Gola did not anticipate any large demand issues with Wednesday's 20-year auction, noting that large tails are rare. The bond auction is also a new issue, which should typically see more demand than reopenings.

Analysts at JPMorgan noted in a report on Tuesday that foreign participation at April's 20-year auction held steady at 8% even as demand from end-users declined on the month.

Still, "given still elevated policy uncertainty amid a worsening fiscal outlook", yields at the auction may be higher than the market is pricing heading into the sale, they said.

The Treasury will also sell $18 billion in 10-year Treasury Inflation-Protected Securities on Thursday.

The 20-year bond yield US20YT=RR was last up 3.5 basis points on the day at 5.038%.

The 2-year note US2YT=RR yield, which typically moves in step with interest rate expectations, rose 3.9 basis points to 4.009%.

The yield on benchmark U.S. 10-year notes US10YT=RR rose 5.2 basis points to 4.533%.

The yield curve between 2-year and 10-year notes US2US10=TWEB steepened by around 1 basis point to 52.5 basis points.

The 30-year bond US30YT=RR yield rose 4.2 basis points to 5.009%.

(Reporting by Karen Brettell; Editing by Nick Zieminski and Joe Bavier)

((karen.brettell@thomsonreuters.com;))