TREASURIES-US yields sink as Fed rate cuts still on track after CPI data

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US core inflation rises 0.2%, as expected

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US 10-year yield has 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 38 bps of easing in 2025

(Adds new comment, updates prices)

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 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.

"Today was probably short-covering from a positioning standpoint just looking at the magnitude of the move," said Mike Sanders, portfolio manager and head of fixed income at Madison Investments in Madison, Wisconsin.

"It was a good number: shelter was less than what it was in the prior two months, core services were a tad slower and core goods were also a touch lower. But the magnitude of the (rates) move, considering the slight beat in forecasts, seems a little bit much," he added.

The U.S. 10-year yield fell for a second straight day, and by late U.S. afternoon was down 13.1 basis points at 4.657%, , its largest daily fall since late November.

The U.S. two-year yield, which reflects interest rate expectations, fell 9.7 basis points to 4.268%, its biggest one-day decline in absolute terms in roughly two months.

Following the data, the U.S. rate futures market has fully priced in a pause in easing at the Fed meeting later this month, and factored in 38 bps of cuts this year, according to LSEG estimates. That was up from about 26 bps of easing late Tuesday. Wednesday's numbers though still showed less than two rate reductions of 25 bps each.

James Knightley, chief international economist at ING, wrote in a research note after the CPI report, that the inflation trend "remained too hot for comfort," and said there is greater likelihood that the Fed pause is extended well beyond January.

"Nonetheless, the near 10% jump in the trade-weighted dollar since September and the surge in Treasury yields -- still up more than 100 basis points since September despite today's moves -- will be headwinds to growth. (That) will help dampen inflation pressures too....and should give the Fed greater scope to respond with lower rates in the second half of 2025."

The U.S. yield curve, meanwhile, flattened or reduced its steepness following the inflation report, with the spread between two- and 10-year yields last at 38.7 bps, compared with 42.3 bps on Tuesday.

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

On Monday for instance, the yield curve hit 47.7 bps, its steepest since May 2022.

(Reporting by Gertrude Chavez-Dreyfuss; additional reporting by Caroline Valetkevitch in New York; Editing by Emelia Sithole-Matarise, Kirsten Donovan and Chizu Nomiyama)