TREASURIES-US yields dip after Fed's Waller comments, softer-than-expected data

Adds analyst comments, details on US economic data, Fed's Waller's comments, bullets, byline; updates prices

By Gertrude Chavez-Dreyfuss

NEW YORK, Jan 16 (Reuters) - U.S. Treasury yields slipped on Thursday, after trading higher for most of the session in a choppy market, following comments from Federal Reserve Governor Christopher Waller who said three or four interest cuts this year are still possible if U.S. economic data weakens further.

U.S. rate futures were pricing in about 40 basis points (bps) of rate cuts in 2025 after Waller's remarks, from about 37 bps late on Wednesday, according to LSEG data. The market also factored in a 50% chance that the next rate reduction will likely take place at the Fed's May meeting.

A barrage of data in the world's largest economy showing weaker-than-expected numbers in retail sales and initial jobless claims also weighed on Treasury yields as did tame import prices, which suggested inflation remained stable.

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

"Our base case is still two cuts this year and that's predicated on the notion that we will get some slowing inflation," said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income in New York.

"The Fed will want to cut rates to make sure that the expansion continues. But even though there would be 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," he added.

Thursday's data showed that 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.

Stan Shipley, managing director and fixed income strategist at Evercore ISI in New York, said the jobless claims outcome was "probably due to less than normal seasonal temporary hiring in November and early December," suggesting there could fewer seasonal layoffs in early January.

U.S. import prices, meanwhile, barely rose for a third straight month in December, with the surge in the costs of fuel and food offset by weakness elsewhere, indicating a tame inflation outlook. The data matched economists' forecasts.

The lone surprise was the Philadelphia Fed Business Index, which jumped to 44.3 in January, compared with a forecast of minus 5. That was the largest increase since April 2021.

Some analysts said the Philly Fed reading could be an aberrant reading.

In mid-morning trading, the benchmark Treasury 10-year yield was down 1.8 bps at 4.635% US10YT=RR. It was at 4.694% before the data. On the short end of the curve, the two-year yield, which reflects interest rate expectations, last traded down 1.1 bps at 4.255%, compared with 4.314% prior to the reports.

The U.S. yield curve, meanwhile, flattened slightly or reduced its steepness following the economic data, with the spread between two- and 10-year yields last at 38.2 bps US2US10=TWEB, compared with 38.5 bps on Wednesday.

The curve briefly steepened after Waller's remarks.

Yield curves typically steepen, tracking an upwardly sloping shape, in the midst of an easing cycle, as the front end remains anchored, mirroring rate cuts by the Fed.

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

((gertrude.chavez@thomsonreuters.com; 646-301-4124;))