(Bloomberg) -- The Treasury market rallied as traders grew more confident the Federal Reserve will cut interest rates this year, emboldened by an ebb in US inflation and weaker-than-expected retail sales data.

The surge on Wednesday pushed 10-year yields lower by as much as 10 basis points to 4.34%, the lowest in more than a month, before paring some of the move. Traders in interest-rate swaps priced in more than 80% odds that US policymakers cut rates by a quarter-point by September — and about a one-in-four chance of a reduction in July.

“The implications of the CPI data is that it brings even a July Fed cut into play,” said Glen Capelo, managing director at Mischler Financial. “That’s all bullish for the front-end of the Treasury market.”

A government report showed the so-called core consumer price index, which excludes food and energy costs, increased 0.3% from March, matching economists’ forecast and marking the first slowdown in six months. A separate report showed retail sales stagnated in April after downwardly revised gains in the prior two months.

Following the report, investors pared their expectations for inflation. Five-year break-even rate, which tracks yield differences between Treasuries and inflation-linked bonds, fell to 2.3%, the lowest since February. Yields across the bond spectrum dropped. 

Wednesday’s data followed a string of recent economic reports, including payrolls and the University of Michigan survey of consumer confidence, that showed the economy may be cooling under the weight of the highest borrowing costs in more than two decades. Bloomberg’s Economic Surprise Index, which tracks activity data relative to economists’ estimates, fell to the lowest since July 2022.

These indicators helped the bonds this month reverse more than half of April’s brutal losses. Ten-year yields had surged almost 50 basis points last month amid hot inflation data that cast doubt on whether the Fed would be able to lower interest rates in 2024 at all. 

In the run-up to the latest release, though, traders in the options market had positioned for a rally. Option flows after the release show that traders took profit on those bullish bond wagers, including heavy sales in Treasury call options for the July tenor. It’s a potential sign that the bond advance could stall as investors refocus on the fact that Fed officials will need even more data to support a policy move. 

Chair Jerome Powell said on Tuesday that recent figures indicate it will likely take more time than previously thought to attain the confidence needed to lower interest rates. Interest-rate swaps showed traders have almost fully priced in two cuts by December, in line with the median projection that Fed officials laid out in the so-called dot-plot at the March policy meeting.

“People hear cuts, and I think that immediately conjures up images of the Fed getting aggressive,” said Tom Porcelli, chief US economist at PGIM Fixed Income, on Bloomberg Television. “We don’t think that’s the case. We think this is going to be a very modest reduction.”

--With assistance from Liz Capo McCormick.

(Updates with more detail throughout.)

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