TREASURIES-US yields fall as inflation data keeps Fed on track for rate cuts this year

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US 10-year yield on pace for largest daily fall in two months

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US 2/10 yield curve flattens after inflation data

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US rate futures price in 40 bps of easing in 2025

(Adds analyst comment, details of CPI, byline)

By Gertrude Chavez-Dreyfuss

NEW YORK, Jan 15 (Reuters) - U.S. Treasury yields fell on Wednesday after data showed underlying inflation in the world's largest economy softened last month, suggesting that the Federal Reserve remained on track to cut interest rates this year.

The number of cuts, however, remained up for debate, but the inflation report suggested that a rate hike this year, which some in the market had entertained given the strength of recent economic data, was off the table, for now.

Data showed that the headline consumer price index rose 0.4% last month after climbing 0.3% in November. In the 12 months through December, the CPI advanced 2.9% after increasing 2.7% in November. Economists polled by Reuters had forecast the CPI gaining 0.3% and rising 2.9% year-on-year.

However, excluding the volatile food and energy components, the CPI increased 0.2% in December, after a 0.3% rise in the previous month. The so-called core CPI had risen 0.3% for four straight months. In the 12 months through December, core CPI increased 3.2% after climbing 3.3% in November.

"There was a growing fear that inflation pressures would cause the Fed to have to even contemplate raising rates in the near term and that's taken off the table just a bit," said Brent Schutte, chief investment officer, at Northwestern Mutual Wealth Management Company in Milwaukee.

"It doesn't mean that the Fed is going to ease. I think they're on hold. But just in general, you've seen rates rise quite a bit over the past few weeks... Today's (data) pushes that to the back burner a bit for now."

In mid-morning trading, the U.S. 10-year yield fell for a second straight day, and was last down 11.7 basis points (bps) at 4.671%, on pace for its largest daily fall since late November.

The U.S. two-year yield, which reflects interest rate expectations, dropped 9.3 bps to 4.270%. It's on track to post its biggest one-day decline in roughly two months.

Following the data, the U.S. rate futures market priced in 40 bps of cuts this year, up from about 26 bps in easing late Tuesday. Wednesday's numbers though still showed less than two rate reductions of 25 bps each.

The U.S. yield curve, meanwhile, flattened or reduced its steepness following the inflation report, with the spread between two- and 10-year yields touching 39.9 bps , compared with 42.3 bps on Tuesday.

The flattening, however, did not suggest a change in trend, but rather a position unwinding after the curve steepened sharply or widened its gap since early December.

On Monday for instance, the yield curve touched 47.7 bps, its steepest since May 2022. (Reporting by Gertrude Chavez-Dreyfuss; Additional reporting by Medha Singh in Bengalaru; Editing by Emelia Sithole-Matarise)