Treasury two-year yields dropped to the lowest level since May as a surprise decline in producer prices reinforced bets on Federal Reserve rate cuts this year.

Traders are pricing in an about 80 per cent chance of a Fed reduction in March — up from a little over 50 per cent a week ago. Friday’s economic data came a day after a hotter-than-estimated reading on consumer prices — underscoring the bumpy path officials face in bringing inflation to the 2 per cent target. Investors also sifted through bank results as the U.S. earnings season kicked off, while watching geopolitical developments ahead of Monday’s Martin Luther King Jr. Day.

“We suspect there is little to dissuade the market from pressing the March cut trade,” said Ben Jeffery at BMO Capital Markets. “Let us not forget the geopolitical escalations in the Red Sea and the implied headline risk — relevant from both a flight-to-quality and supply-side inflation perspective.”

Two-year U.S. yields fell 10 basis points to 4.15 per cent. Traders priced in about 20 basis points of easing for March. Given that Fed rate changes historically have been increments of 25 basis points, swap contracts still show bets on the first cut in May. The S&P 500 was little changed Friday, while notching a weekly gain. Microsoft Corp. overtook Apple Inc. to become the world’s most-valuable publicly traded company. Bitcoin slid. Oil rose as the US and its allies launched airstrikes against Houthi rebels in Yemen.

Among the key reasons for the decline of inflation over the past year were a drop in energy costs and supply chains that had largely ironed out their pandemic strains. The Red Sea turmoil is hampering both of those disinflationary forces that central bankers were hoping could help them finish the job.

“This is a world in which we are fragile to begin with on the supply side, and then you get this additional shock,” Mohamed El-Erian, president of Queens’ College, Cambridge, and a Bloomberg Opinion columnist, said Friday in an interview on Bloomberg Television.

To Chris Larkin at E*Trade from Morgan Stanley, it may be a bit of stretch to describe Friday’s cooler-than-expected inflation numbers as a “surprise” given that producer prices have already retreated faster than consumer figures for quite a while.

“The market has tended to run with any data that fits the ‘falling inflation means lower interest rates’ narrative, but we’ll see if that storyline bumps up against the reality of a market that has already priced in multiple rate cuts,” he noted.

Yet the Fed can still take solace in inflation that’s slowed since peaking in mid-2022, with the trend of diminishing price pressures explaining why policymakers are penciling in reductions in interest rates in 2024.

Investors have slashed expectations for hawkish surprises from the Fed this year, while they see a growing risk of such moves from central banks in the euro zone and other regions, Bank of America’s latest monthly sentiment survey shows.

The number of respondents who anticipate a more hawkish move on policy than market pricing fell to 33 per cent in the bank’s latest poll, from 51 per cent in December. Despite the slide, “the Fed is still viewed as more likely to deliver a hawkish surprise than others,” BofA strategists including Ralf Preusser wrote in a note.

Economists at Barclays expect an earlier start to Fed easing — now calling for the first one in March instead of June.

“Given the recent progress on inflation, we think the FOMC will be comfortable cutting rates without needing to see a substantial weakening of the economy or the labor market,” Marc Giannoni and Jonathan Millar wrote.

After the big fourth-quarter rally in US stocks, investors are shifting gears to what companies have to show for it in their earnings scorecards.

Not much is baked into expectations, so there’s room for an upside surprise: Analysts project that S&P 500 members will see fourth-quarter profits grow 1.1 per cent on average from a year earlier, which would be the smallest positive figure since before the pandemic, data compiled by Bloomberg Intelligence show. The equities benchmark surged 11 per cent last quarter, the best performance since 2020.

On Friday, leaders at some of Wall Street’s biggest banks took turns calling an end to the record run for their biggest source of revenue. Wells Fargo & Co. surprised analysts by predicting a 9 per cent drop in net interest income for 2024, while Citigroup Inc. forecast a modest drop this year. Even JPMorgan Chase & Co., which sees its 2024 haul holding up at 2023 levels, predicts it will drop off over the course of the year.

Corporate Highlights:

• JPMorgan Chase & Co. closed out the most profitable year in US banking history with its seventh consecutive quarter of record net interest income and a surprise forecast that the windfall may continue this year.
• Wells Fargo & Co.’s fourth-quarter costs came in higher than expected, swollen by severance charges and the bank’s contribution to replenish the Federal Deposit Insurance Corp.’s main fund after bank failures last year.
• Citigroup Inc. said it will eliminate 20,000 roles in a move that will save it as much as $2.5 billion as part of Chief Executive Officer Jane Fraser’s quest to boost the Wall Street giant’s lagging returns.
• Bank of America Corp.’s earnings fell short of expectations as the bank’s numerous charges in the fourth quarter cut into profit and the firm’s fixed-income traders posted a surprise drop in revenue.
• BlackRock Inc. clients jumped into its long-term funds in the fourth quarter, adding $63 billion to ETFs and other products in a sign investors put cash to work as stock and bond markets surged.
• Delta Air Lines Inc. backed away from its 2024 profit target as persistently high costs counter the gains from a rebound in international travel.
• The U.S. Federal Aviation Administration said it will increase its oversight of Boeing Co.’s production and manufacturing operations, a day after it opened a formal investigation into the planemaker over last week’s accident on a 737 Max 9 jet.
• Lockheed Martin Corp. and NASA plan to give the public a sneak peek of a plane that could pave the way for airlines to dramatically speed up flights.
• Some Dish Network Corp. creditors are examining legal options including sending a default notice to the company after it moved prized assets out of bondholders’ reach, according to people with knowledge of the matter.
• UnitedHealth Group Inc. reported higher fourth-quarter medical costs than Wall Street analysts expected, even as overall results beat estimates.

Some of the main moves in markets:

Stocks

• The S&P 500 was little changed as of 4 p.m. New York time
• The Nasdaq 100 was little changed
• The Dow Jones Industrial Average fell 0.3 per cent
• The MSCI World index rose 0.3 per cent

Currencies

• The Bloomberg Dollar Spot Index was little changed
• The euro fell 0.2 per cent to $1.0950
• The British pound fell 0.1 per cent to $1.2745
• The Japanese yen rose 0.3 per cent to 144.92 per dollar

Cryptocurrencies

• Bitcoin fell 5.1 per cent to $43,796.86
• Ether fell 1.2 per cent to $2,572.03

Bonds

• The yield on 10-year Treasuries declined two basis points to 3.94 per cent
• Germany’s 10-year yield declined five basis points to 2.18 per cent
• Britain’s 10-year yield declined five basis points to 3.79 per cent

Commodities

• West Texas Intermediate crude rose 1 per cent to $72.73 a barrel
• Spot gold rose 0.9 per cent to $2,047.15 an ounce

This story was produced with the assistance of Bloomberg Automation.