TREASURIES-US yields decline after Fed's Waller's remarks, soft data

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Fed's Waller says three or four cuts possible this year

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US retail sales, jobless claims softer than expected

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Philly Fed Index surges, analysts say could be an aberration

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US 2/10 yield curve flattens slightly

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US rate futures price in 43 bps of easing in 2025

(Adds comment, graphic, updates prices)

By Gertrude Chavez-Dreyfuss

NEW YORK, Jan 16 (Reuters) - U.S. Treasury yields fell on Thursday after Federal Reserve Governor Christopher Waller said three or four interest rate cuts this year are still possible if U.S. economic data weakens further.

U.S. rate futures were pricing in about 43 basis points (bps) of rate cuts in 2025 after Waller's remarks, from about 37 bps late Wednesday, according to LSEG data. The market also factored in a 69% chance that the next rate reduction would likely take place at the Fed's June meeting.

Before Waller's remarks, traders had expected the next rate cut would be sometime after the first half of the year.

Inflation "is getting close to what our 2% inflation target would be," Waller said on CNBC, citing estimates indicating that one key measure of underlying inflation, the Personal Consumption Expenditures Price Index excluding food and energy costs, has been close to the Fed's target for six of the past eight months.

A barrage of U.S. data showing weaker-than-expected numbers in retail sales and initial jobless claims also weighed on Treasury yields, as did tame import prices, which suggested that inflation remained stable.

Thursday's reports also dampened the U.S. growth outlook and supported expectations that the Fed would cut rates at least once this year. Prior to the numbers and Wednesday's soft core inflation data, some investors had started to price in a Fed that would keep rates on hold all year, with a few already factoring in a hike.

"The softening of data, where we're comparing with very high comps from last year, should make the year-on-year number trend in the right direction," said John Luke Tyner, head of fixed income and portfolio manager at Aptus Capital Advisors in Fairhope, Alabama.

"I think that if we see a couple more data prints like what we saw yesterday (decline in U.S. core prices) and today, similar cuts will be going to get priced back into the market, at least two rate cuts to be in line with what the Fed has communicated."

Thursday's data showed U.S. retail sales rose less than expected in December, up 0.4%, compared with a forecast for a 0.6% increase, although the previous two months were revised higher. Initial jobless claims, on the other hand, increased to 217,000, after falling in the previous week.

U.S. import prices, meanwhile, barely rose for a third straight month in December, indicating a tame inflation outlook.

The lone surprise was the Philadelphia Fed Business Index, which jumped to 44.3 in January, compared with a forecast of minus 5, which some analysts suggested could be an aberrant reading. That was the largest increase since April 2021.

In afternoon trading, the benchmark Treasury 10-year yield slid 6.1 bps to 4.592%. U.S. 30-year yields eased 4.7 bps to 4.831.

On the front end, the two-year yield, which reflects interest rate expectations, last traded down 3.4 bps at 4.23%.

The U.S. yield curve, meanwhile, flattened or reduced its steepness following the economic data, with the spread between two- and 10-year yields last at 36 bps, compared with 38.5 bps on Wednesday. The curve briefly steepened after Waller's remarks.

Analysts said bond investors have been unwinding their steepener trades, or strategies involving bullish bets on short-dated Treasuries such as the two-year note and bearish wagers on longer-dated exposure like the 10-year, given how much the gap between the two maturities has widened since early December.

Yield curves typically steepen, tracking an upwardly sloping shape, in the midst of an easing cycle. That remains a popular trade in the bond market.

"The Fed will want to cut rates to make sure that the expansion continues," said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income in New York. "But even with the rate cuts...I don't think you'll get a big drop in long-term interest rates because as we have seen in recent months, the yield curve is normalizing."

(Reporting by Gertrude Chavez-Dreyfuss; Editing by Chizu Nomiyama, Hugh Lawson and Diane Craft)