(Recasts, updates yields, adds analyst quote)
By Kate Duguid
NEW YORK, June 13 (Reuters) - Increased expectations of Federal Reserve interest rate cuts pulled short-dated yields lower on Thursday, steepening the yield curve ahead of retail sales data on Friday and the meeting of Fed policymakers next week.
The two-year yield, a proxy for market expectations of rate cuts, was 6.2 basis points lower at 1.830% after the Labor Department on Thursday morning reported that import prices fell by the most in five months in May. It was the latest indication of muted inflation pressures, which could strengthen the case for the Fed to cut interest rates this year.
“The inflation data has been coming in very favorable: import prices today, CPI yesterday, PPI on Tuesday. So we’re definitely not seeing an inflation problem,” said Mary Ann Hurley, vice president, fixed income trading, D.A. Davidson.
In a separate Labor Department report on Thursday, the number of Americans filing applications for unemployment benefits unexpectedly rose.
Signs of a slowing labor market and tepid inflation strengthen the case for the Fed to cut interest rates this year.
The spread between the two- and 10-year yields , the most common measure of the yield curve, rose to 25.8 basis points as the fall in short-dated yields pushed the curve steeper. Still, traders held off from taking big positions before Friday’s retail sales report.
“We do have retail sales tomorrow and that is definitely more important than any of the data points we got today,” said Hurley.
U.S. central bank policymakers are scheduled to meet on June 18-19 against the backdrop of rising trade tensions. Financial markets have priced in at least two rate cuts by the end of 2019.
The probability of a cut in July was slightly lower at 64.5% from the prior day, according to CME Group’s FedWatch tool, as more traders placed bets on the Fed cutting rates as early as June. A rate cut next week is now expected by about 29.2%, versus 23.3% Wednesday and 16.7% a week prior.
Also on Thursday, the Treasury Department auctioned off $16 billion of 30-year bonds to solid demand. Yields fell modestly following the auction.
“We interpret the strong demand as a sign of perhaps the last round of short covering before the curve breaks steeper. A dovish message from the Fed next week could be the big catalyst,” wrote Tom Simons, senior money market economist at Jefferies. (Reporting by Kate Duguid Editing by Chizu Nomiyama)