By Sinéad Carew

NEW YORK (Reuters) – The S&P 500 and Nasdaq turned negative while Treasury yields rose as investors digested signs of cooling U.S. inflation and bets the Federal Reserve could slow its rate hikes against warnings that the battle with rising prices was far from over.

Thursday’s data showed U.S. producer prices unexpectedly fell in July amid a drop in the cost of energy products. This followed Wednesday’s surprise news that consumer prices were unchanged in July due to a drop in gasoline prices.

But meanwhile, U.S. Treasury yields rallied after dropping sharply earlier.

Two straight days of slower inflation data had given investors hope that soaring prices were finally “peaking and heading in the right direction,” said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.

But he cautioned that this was a “one month data point.”

“You’d still like to see a trend next month and see it’s not necessarily just energy. You want to see other prices coming down. It’s still early in the game,” Saluzzi said.

After adding more than 2% on Wednesday and rising more than 1% to a 3-month high earlier on Thursday, the S&P turned red in afternoon trading and Nasdaq turned negative.

The Dow Jones Industrial Average rose 28.71 points, or 0.09%, to 33,338.22, the S&P 500 lost 2.12 points, or 0.05%, to 4,208.12 and the Nasdaq Composite dropped 70.92 points, or 0.55%, to 12,783.88. [.N]

The pan-European STOXX 600 index closed up 0.06% and MSCI’s gauge of stocks across the globe gained 0.1%.

“In some regards we’ve already priced in the hope that inflation isn’t going to be as bad as previously expected and the expectation the Fed is not going to be as aggressive,” said Robert Phipps, a director at Per Stirling Capital Management in Austin, Texas.

He expects that the Fed to be cautious about slowing its tightening until inflation shows more improvement.

“The Fed’s learned their lesson. They’re not going to take their foot off the brakes until it’s obvious to everybody that inflation is returning to their 2% target,” he said.

San Francisco Fed President Mary Daly, in an interview with the Financial Times, earlier warned it was far too early for the U.S. central bank to declare victory in its fight against inflation and said a half-percentage point rate rise in September was her baseline.

Daly’s comments followed similar cautions from Minneapolis Federal Reserve Bank President Neel Kashkari and Chicago Fed President Charles Evans on Wednesday.

In currencies, the dollar extended losses against other majors after the inflation data prompted traders to dial back rate hike expectations.

In Treasuries, 10-year note yields hit a more than two-week high as investors in that market bet that the Fed would press on with rate hikes since inflation, while showing signs of abating, remained high.

Benchmark 10-year notes last fell 29/32 in price to yield 2.8839%, from 2.781% late on Wednesday. The 30-year bond last fell 76/32 in price to yield 3.1682%, from 3.042%. The 2-year note last fell 1/32 in price to yield 3.2289%, from 3.214%. [US/]

In currencies, the dollar index fell 0.114%, with the euro up 0.25% at $1.0323.

The Japanese yen weakened 0.01% versus the greenback to 132.94 per dollar, while sterling was last trading at $1.2196, down 0.24% on the day. [FRX]

In commodities, oil settled higher after the International Energy Agency raised its oil demand growth forecast for 2022 as soaring natural gas prices lead some consumers to switch to oil. [O/R]

U.S. crude settled up 2.6% at $94.34 per barrel and Brent finished at $99.60, up 2.3% for the day.

Spot gold dropped 0.3% to $1,787.61 an ounce. [GOL/]

(Additional reporting by Huw Jones, Sujata Rao, Stella Qiu and Alun John; Editing by Elaine Hardcastle, David Holmes and John Stonestreet)