TREASURIES-US government bonds rally as oil cools, but Iran risks linger

By Gertrude Chavez-Dreyfuss

NEW YORK, March 16 (Reuters) - U.S. Treasuries rebounded on Monday, with risk appetite improving, as oil prices retreated and stock markets recovered, although gains were tempered as bond investors continued to assess how long the war in Iran may last amid mixed signals.

The benchmark 10-year yield US10YT=RR, which falls when prices rise, slid 6.3 basis points (bps) to 4.222% after tumbling for five straight days. It was on track for its largest daily decline since mid-February. U.S. two-year yields were also down, dipping 5.2 bps to 3.682%. It was set for its biggest one-day fall since late February.

A sharp rally in oil prices — and the prospect of broader global inflation pressures — drove the surge in yields across the curve last week. U.S. crude futures CLc1 have spiked more than 40% since the beginning of March, on pace for the biggest monthly gain since May 2020.

Market players said risk appetite was slightly higher compared to last week as there have been discussions about ending the conflict, or some resolution on how to end it.

President Donald Trump also called for a coalition of nations to help reopen the vital Strait of Hormuz and warned that the NATO alliance faces a "very bad" future if its members fail to come to Washington's aid.

"The trend that we saw last week is just reversing a little bit as the market is just trying to figure out, where do we go from here, almost like a little bit of a recalibration," said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania.

"The market, at this point, given the way it's trading, feels as if we're going to have some short-term volatility here, but there is an end game at some point. It's not going to go on forever, and the market's just repositioning for that."

U.S. 30-year yields also slid, down 4.3 bps at 4.865% US30YT=RR, on pace for the biggest daily pullback since February 12.

The yield curve was flatter on the day, with the gap between two-year and 10-year yields narrowing to 54 bps US2US10=TWEB from 55.8 bps late on Friday. The move largely reflected expectations that the Fed may not cut interest rates as aggressively as previously thought due to the inflationary impact of the recent surge in oil prices.

With inflation rearing its ugly head again, U.S. rate futures have priced in just one Fed cut this year, or about 24 bps, from 55 bps before the war, according to LSEG estimates.

Inflation swaps, a gauge of the outlook for future consumer prices, saw a spike to a nearly five-month peak of roughly 3% USCPIZ1Y= in one-year maturities last week. This means investors believe that the consumer price index will average about 3% over the next 12 months, higher than the 2.4% year-on-year CPI reading for February.

On Monday, that inflation measure slipped 2.9% with the drop in oil prices.