(Updated at 1445 EDT)

By Karen Brettell

NEW YORK, Aug 9 (Reuters) -

Longer-dated U.S. Treasury yields fell on Friday after a

volatile week driven by concerns about the U.S. economic

outlook, while investors turned to key inflation data next week

for fresh clues on the potential size of an expected September

rate cut.

Yields have regained ground over the week after a dramatic

bond rally sent them to more than one-year lows on Monday, with

stock markets also recovering from a rout that was in part

blamed on the unwind of popular dollar/yen carry trades.

A bigger-than-expected drop in jobless claims on Thursday

helped ease worries about the possibility of an imminent U.S.

recession. Concerns rose after last Friday's non-farms payroll

report showed an unexpected increase in unemployment.

"The main theme of the bond market at the beginning of the

month was concerns about the state of the labor market and the

future path of the Fed," said Lou Brien, market strategist at

DRW Trading in Chicago. Then "there was a lot of noise that was

added onto markets because of the Yen carry trade."

That trade involves borrowing yen at a low cost to finance

U.S. asset purchases, including tech stocks. A sharp rise in the

yen against the U.S. dollar, however, led traders to unwind

these positions.

Yields on interest rate-sensitive two-year notes

rose 1.1 basis points on the day to 4.055% and are up 18 basis

points on the week, the biggest one week increase since March.

Benchmark 10-year note yields fell 5.3 basis

points to 3.944% and are up 15 basis points this week, the

largest one week increase since April.

The yield curve between two- and 10-year Treasury notes

flattened 6 basis points to minus 11 basis

points. It reached 1.50 basis points on Monday, turning positive

for the first time since July 2022.

The Fed is expected to cut rates at its next policy meeting

on Sept. 17-18, but traders are grappling whether a 25 or 50

basis point reduction is more likely.

Stephen Gola, head of U.S. Treasuries Sales & Trading at

StoneX Group in New York, said that markets may be

overestimating the odds of a 50 basis points cut.

The Fed has "been very deliberate and slow-moving trying to

adhere to their own tenet of policy working with long and

variable lags," he said. "Rush it when you need to, but

otherwise we do live in 25 basis point increment world and we're

not falling apart at the seams."

Traders are currently pricing in a 51% probability of a 50

basis point cut, and 49% odds of a 25 basis point reduction,

according to the CME Group's FedWatch Tool. A 50 basis-point cut

had been fully priced in on Monday and traders had begun

speculating on a possible emergency cut before September.

Fed policymakers on Thursday said they are increasingly

confident that inflation is cooling enough to allow

interest-rate cuts ahead, and they will take their cues on the

size and timing of those rate cuts not from stock-market turmoil

but from the economic data.

Consumer price data on Wednesday is the next major data

point and is expected to show that inflation continues to edge

down closer to the Fed's 2% annual target.

Annual core price growth is expected to slow to 3.2% in

July, from 3.3% in June, and headline prices are expected to

stay steady with a 3% annual gain, according to economists

polled by Reuters.

"I'm concerned about a surprise on the headline if there's

anything quirky in the data, but our base case is inflation is

moving lower," said Zachary Griffiths, senior investment grade

strategist at CreditSights in Charlotte.

"The economy is slowing, driven by the consumer that's just

running out of steam, running out of excess savings and starting

to see this increase in the unemployment rate, which should work

its way through to the spending and inflation numbers."

Assuming there are no upside surprises in inflation, jobs

data and the unemployment rate in particular will likely remain

the key focus for traders.

"Concerns about the state of the labor market and the pace

that the Fed's going to go remain valid and will come more

clearly into focus over the coming weeks," said DRW's Brien. "A

lot of the components of the labor market have been weakening

for a substantial amount of time and will continue to."

Comments by Fed Chair Jerome Powell at the Fed's Jackson

Hole Economic Policy Symposium on Aug. 22-24 may also provide

new clues on the path of rate cuts.