The bond market was jolted Thursday by weaker-than-expected January retail sales data that bolstered expectations for Federal Reserve interest-rate cuts starting in June.

Treasury yields retreated further from year-to-date highs reached Tuesday, but failed to sustain the move amid lingering doubts about the potential for sticky inflation to delay rate cuts.

This week’s yield highs were reached in a selloff sparked by hotter-than-anticipated inflation data that caused traders to abandon wagers on a Fed rate cut sooner than June. Signs that inflation anxiety remains potent included strong demand for Treasury options strategies targeting 10-year yields to exceed 4.4% in the coming weeks, a level last seen in November. “It’s been whiplash this week,” said Gregory Faranello, Head of US interest rates at AmeriVet Securities. “The Fed is telling the market, ‘We are not ready to lower rates,’ and the data has co-operated for the most part.”

The retail sales data broke with that trend, and yields sank across the curve. The two-year, for example, fell as much as 8 basis points to just under 4.50% before erasing the drop.

Likewise, derivatives traders priced in higher odds of Fed rate cuts this year, but the market failed to sustain them. For months, bond investors have been dealing with clashing narratives on the US economy. Progress toward lower inflation has shaped the view that the Fed can cut interest rates from multiyear highs to avoid pushing the economy into a recession.

At the same time, the economy has outperformed expectations, giving the central bank cover to delay. The January retail sales data “stamps out the over-heating economy narrative that was starting to percolate,” Earl Davis, head of fixed income and money markets at BMO Global Asset Management, said. “Our sense is that we will still see higher rates in the short term as the possibility of eases in March, May and June continues to get pushed out.”

Strong Growth

The hotter-than-expected consumer price index readings earlier this week led markets to pare wagers on a cut before June and trim the amount of easing expected for this year to fewer than four quarter-point rate cuts from almost five a week ago. The climb in yields left the Bloomberg US Treasury Index down 1.9% this year through Wednesday. US retail purchases, unadjusted for inflation, decreased 0.8% from December after a downward revision to the prior month, Commerce Department data showed Thursday.

The drop was the biggest in nearly a year. So-called control-group sales — which are used to calculate gross domestic product — dropped 0.4% in January, the first decline since March. “Rates markets seem to like the retail report,” said Jan Nevruzi, US rates strategist at NatWest Markets. “The control group in retail sales is showing weakness, which will feed into the first-quarter GDP.”

Other US economic data released Thursday were mixed, with business surveys conducted this month by the Federal Reserve banks of New York and Philadelphia improving more than anticipated, and weekly initial jobless claims showing an unexpected decline. January industrial production was weaker than economists estimated, however.

Friday brings reports on January producer prices and housing starts, and February consumer sentiment. “The growth story is much stronger than people expected coming into the year,” Tony Rodriguez, head of fixed-income strategy at Nuveen Asset Management, said on Bloomberg Television Wednesday. Inflation “at the margin is worse than it had been a month ago, but not materially different,” and doesn’t warrant higher yields for 10-year Treasuries, he said.

–By: Ye Xie and Michael Mackenzie with assistance from Edward Bolingbroke