TREASURIES-Yields recover from early fall on hopes of Middle East breakthrough

By Matt Tracy

WASHINGTON, March 25 (Reuters) - U.S. Treasury yields fell sharply on Wednesday, before recovering in late morning trading, on reports of progress in peace efforts in the Middle East conflict.

The benchmark 10-year Treasury yield US10YT=RR was last down 6.8 basis points at 4.324%. It earlier reached a session low of 4.308%.

The yield on two-year notes US2YT=RR was last down 5.7 bps at 3.879%, after earlier in the morning reaching as low as 3.852%.

U.S. Treasury yields rose on Tuesday after an auction of $69 billion in two-year notes met underwhelming demand, as market uncertainty persists around the Iran war and elevated oil prices.

"So I think that the auction results in general just show that investors are still hesitant to bid aggressively for the front end of the curve, despite the seemingly attractive valuations," said Vail Hartman, U.S. rates strategist at BMO Capital Markets.

"The auction was just a compounding factor for the sell-off associated with geopolitics," Hartman later added.

The Treasury Department is slated to auction $70 billion in five-year notes later on Wednesday.

Yields declined early on Wednesday after reports that the U.S. had sent Iran a peace plan, as well as that Iran would allow certain ships through the Strait of Hormuz, a vital pathway for oil shipments.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=RR, viewed in the market as an indicator of economic expectations, was last at 44.14 basis points.

U.S. rate futures on Friday began to price in the possibility of an interest-rate hike later this year after the Fed and other central banks last week kept rates on hold. Markets last priced in a 95.9% chance of no hike for the Fed's April meeting, slightly lower than in the morning.

"Yields could remain elevated in the near-term as the Fed remains in 'wait-and-see' mode, but worries about slowing growth could limit the move higher," Oscar Munoz, chief U.S. macro strategist at TD Securities, wrote in a Wednesday note.

Yields reached their multi-month highs on Monday after U.S. President Donald Trump said he had delayed strikes on Iranian power plants and energy infrastructure, following what he called productive talks with Iran.

They declined shortly after Iran's foreign ministry said there was "no dialogue" between Tehran and Washington, according to state-affiliated media. Iran then announced fresh attacks on U.S. targets, lifting crude oil prices.