US two-year yield falls to lowest since September 2022

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U.S. 2/10 yield curve hits steepest since July 2022

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Fed funds futures price in 61% chance of 50-bp cut

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Focus on U.S. retail sales ahead of Fed decision on Wednesday

(Adds U.S. two-year milestone, bullets; updates yield curve moves, prices)

By Matt Tracy

WASHINGTON, Sept 16 (Reuters) - The U.S. Treasury two-year yield fell to its lowest in two years on Monday, while the 10-year's yield slid for a second straight session, as investors weighed the odds of a half-percentage point interest rate cut by the Federal Reserve this week.

In midday trading, benchmark 10-year Treasury yields dipped 2 basis points to 3.628%, while U.S. two-year yields fell to 3.528%, their lowest since September 2022. They were last down 1.9 bps at 3.557%.

Treasury yields, which move inversely to prices, declined last week after growing speculation around a 50 basis-point (bp)rate cut at the Fed's Sept. 17-18 rate-setting meeting.

Former New York Federal Reserve President Bill Dudley further fanned that speculation when he said on Thursday that there was a strong case for a 50-bp cut, while investors made sizable bets on that outcome.

The yield curve, meanwhile, steepened for a third straight session, with the spread comparing 10-year and two-year yields widening to as much as 10 bps on Monday. That's the steepest since July 2022, with the curve last at 7 bps.

Investors track the yield curve for signals on the U.S. economic outlook.

The probability of a 50-bp easing was last seen at 61% on Monday, up from 45% on Friday, according to LSEG calculations.

A key factor heading into this week's Fed meeting will be how the central bank handles these market expectations, even as inflation has been cooling and the labor market has shown signs of weakness.

"While we're still in the 25-bp camp, we'll concede that the more aggressively the market prices in 50 bp, the more compelled the Fed will be to follow-through with such a move," Ian Lyngen, director of fixed income strategy at BMO Capital Markets, wrote in a research note on Monday.

Some in the market were skeptical, however, about whether such a large cut was necessary as recent signs point to still-sticky inflation, and uncertainty swirls around November's U.S. presidential election.

"I don't think 50 (basis points) is warranted, because 25 gives them more optionality to say, 'Hey, we can do more, but it's an election year,'" said Jack McIntyre, portfolio manager for global fixed income at Brandywine Global Investment Management.

August retail sales data, scheduled for release on Tuesday, will perhaps be the most influential economic data point heading into the Fed's decision on Wednesday, market participants said. (Reporting by Matt Tracy; editing by Jonathan Oatis)