TREASURIES-Yields slip as 2025 trading kicks off with Trump and Fed in forefront

By Alden Bentley

NEW YORK, Jan 2 (Reuters) - U.S. Treasury yields receded further from December highs on the first day of 2025, as a bond sell off unwound despite good prospects for a slower pace of monetary easing and economic proposals from the incoming administration that raised inflation concerns.

Early trading was subdued a day after the midweek New Year holiday.

With the inauguration of President-elect Donald Trump less than three weeks away, his promise to raise import tariffs has alarmed many economists worried about how much more consumers will pay for goods and how it might hit demand, while there is a possibility his proposed tax cuts will worsen the fiscal deficit.

"Although yields have fallen a few basis points from some peaks late last week, lingering concerns about future increases in issuance for coupon Treasuries and the sobering possibility that Fed easing may be close to finished this cycle are dominating market sentiment to start 2025," said Will Campernolle, macro strategist at FHN Financial in a client note.

The yield on benchmark U.S. 10-year notes US10YT=RR was off 3 basis points from late Tuesday at 4.549%. The 30-year bond US30YT=RR yield eased 1.4 basis points to 4.769%. The 2-year note US2YT=RR yield, which typically moves in step with interest rate expectations for the Federal Reserve, was 2.7 bp easier at 4.225%, having touched its lowest level since Dec 13.

A selloff in government debt as the market repriced expectations for Federal Reserve policy in 2025 hoisted the 10-year yield above 4.64% on Dec 26, it's highest level since early May. The two-year yield is not far from it's November-December highs above 4.36%, which were last seen in July as markets were pricing in the start of Fed easing.

The Fed cut the fed funds target rate by 50 bp in September from the range of 5.25%-5.50% where it had stood since July 2023 after a series of aggressive hikes to curb inflation. The central bank then reduced rates another quarter basis point at its November and December meetings.

In economic projections released last month when it lowered the target to 4.25%-4.50% the Fed reduced the number of projected rate cuts in the coming year. The policy makers now expect two interest rate cuts by the end of 2025, down from four in September, and set up the likelihood of a pause in January.

The resilience of the U.S. economy and slow progress bringing inflation down the last stretch to the Fed's 2% target has been highlighted by policy makers from Chair Jerome Powell down. Powell has also said it's too soon to say how Trump's proposed economic policies will affect the economy or Fed policy.

According to the fed funds futures term structure, traders see about an 89% chance the Fed will sit tight in January, with odds for a cut at the March meeting a bit more than 50-50. About 50 bp of reductions are built in by year end.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=RR, seen as an indicator of economic expectations, was at a positive 31.6 basis points, flatter than +32.7 bp late Tuesday, when it reached its steepest since May 2022.

The five-year TIPS US5YTIPS=TWEB breakeven inflation rate was 2.3915%. This suggests that investors think annual inflation will average almost 2.4%, above the Fed's 2% target rate, for the next five years.

(Reporting by Alden Bentley;Editing by Elaine Hardcastle)

((alden.bentley@thomsonreuters.com; 646-281-6041;))