Bond traders shrugged off higher-than-anticipated inflation readings for December, pricing in a larger total amount of Federal Reserve interest-rate cuts this year beginning in May.

While yields surged immediately after the consumer price index showed prices rose more than economists expected, the moves were sustained only until an auction of 30-year bonds cleared the market several hours later. In US afternoon trading, swap contracts that anticipate what the interest rate targeted by the Fed will be in the future repriced to lower levels.

The two-year Treasury note’s yield, more sensitive than longer maturities to Fed moves, declined as much as 10 basis points to 4.26%, the lowest level so far this year. The benchmark 10-year note’s yield fell about 5 basis points to 3.98%.

“There is a broader recognition that rates are moving lower this year and, while there is still going to be volatility, getting exposure to Treasury yields at 4% is attractive,” said Sinead Colton Grant, chief investment officer at BNY Mellon Wealth Management.

The longest-dated Treasury yields remained elevated ahead of the auction of 30-year bonds at 1 p.m. New York time, leading to a steeper yield curve. After the auction produced near-average demand metrics despite offering the lowest yield since August, yields in the 30-year sector and curve spreads retreated from session highs.

Two-year Treasury yields exceeded 10-year yields by less than 30 basis points Thursday for the first time since early November. Last year, the two-year yield for a time was more than a full percentage point higher than the 10-year, reflecting conviction that Fed rate increases would impair economic performance. A 110.9-basis-point gap in March was the biggest since the early 1980s, according to data compiled by Bloomberg.

The Fed’s 11 interest-rate hikes since March 2022 helped push Treasury yields across the curve to multiyear highs in October. Since then, evidence of slowing economic growth and inflation have led the bond market to price in rate cuts in excess of what Fed officials envision. In December, their median end-2024 forecast for the interest rate they control was 4.625%. The market’s estimate declined by about 12 basis points to about 3.8% Thursday.

New York Fed President John Williams Wednesday said that while rates were high enough to restore price stability, rate cuts require more evidence that inflation is headed back toward 2% on a sustained basis. Cleveland President Loretta Mester echoed the message on Bloomberg Television Thursday, saying March was probably too soon to cut rates.

While inflation faces “a bumpier path over the next few months” that may delay the start of Fed rate cuts, “we think there’s plenty of term premium in the market today” and “we’d be looking to buy any rise in yields as we make our way through the next couple months,” Matthew Hornbach, global head of macro strategy at Morgan Stanley, said on Bloomberg Television.

Consumer prices rose 3.4% from a year earlier in December, 3.9% excluding food and energy. Both rates were higher than economists’ median estimates. Separately, weekly jobless claims data showed fewer than expected new claims, a sign of labor-market resilience.

“The inflation pathway from here is going to be bumpy and the pathway to formerly lower rates may prove more complicated than the price action of the prior two months of 2023,” said Gregory Faranello, Head of US Rates Trading and Strategy for AmeriVet Securities.

By: Michael Mackenzie and Liz Capo McCormick