TREASURIES-US bond yields plunge as Middle East ceasefire revives rate-cut bets

By Chuck Mikolajczak

NEW YORK, April 8 (Reuters) - U.S. Treasury yields tumbled on Wednesday after a two-week ceasefire between the United States and Iran ignited a relief rally across asset classes as plummeting oil prices revived the possibility of interest rate cuts by the Federal Reserve this year.

U.S. President Donald Trump on Tuesday agreed to a ceasefire with Iran that was brokered by Pakistan, roughly two hours before his deadline for the Iranians to reopen the critical Strait of Hormuz or face attacks on its civilian infrastructure.

The reprieve could lead to the reactivation of the strategic waterway that typically carries about 20% of the world's oil and gas, and sent oil prices below $100 per barrel and sparked a sharp rally in equities.

U.S. crude CLc1 fell 17.66% to $93.05 a barrel and Brent LCOc1 fell to $92.00 per barrel, down 15.8%, with both on track for their biggest daily percentage declines since April 2020.

"Markets are breathing a huge sigh of relief that Trump and Iran have found an off-ramp for now, and to the extent that this could be the path forward that reduces the odds of a protracted $150 or $200 oil price," said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income in Newark, New Jersey.

"Therefore, you see some drop back in yields as that probability goes down, an improvement in risk appetite with stocks up and credit product outperforming," Tipp said.

The yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB fell 7.9 basis points to 4.264% while the yield on the 30-year bond US30YT=TWEB declined 6.1 basis points to 4.86%. Both were on track for their biggest daily drop since March 30.

The tumble in crude prices helped lift expectations that the Federal Reserve may now have some cushion to cut interest rates this year. Expectations for a cut of at least 25 basis points at the December meeting stand at 34.8%, according to CME's FedWatch Tool, up from the 14.1% in the prior session.

The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, slid 7.4 basis points to 3.759%.

Several Fed officials had said on Tuesday that the sharp rise in oil prices due to the war had posed a risk to inflation, even as it slows the economy and the labor market.

Markets had been pricing in roughly two U.S. rate cuts before the war began on February 28.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=TWEB, seen as an indicator of economic expectations, was at a positive 50.3 basis points.

After a solid $58 billion auction of 3-year notes US3YT=RR on Tuesday, more supply will come to the market on Wednesday with $39 billion in 10-year notes, while a $22 billion auction of 30-year bonds is scheduled for Thursday.

Deutsche Bank said in a note that head of U.S. Treasury trading Ray Johnson expects Wednesday's auction "to go well but is less optimistic about duration after the auction given still elevated uncertainty in the Middle East."

Fed officials scheduled to speak on Wednesday include Bank of San Francisco President Mary Daly and Governor Christopher Waller.

The minutes from the Fed's March meeting will also be released later in the day, and could provide further details on the risks policymakers and central bank staff see from the war.

March inflation data is scheduled to be released on Friday in the form of the consumer price index, and will give an indication of the impact on prices from the war.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) US5YTIP=TWEB was last at 2.569% after closing at 2.644% on April 7.

The 10-year TIPS breakeven rate US10YTIP=TWEB was last at 2.33%, indicating the market sees inflation averaging about 2.3% a year for the next decade.