Oil price surge on Iran conflict raises inflation concerns
February ISM manufacturing PMI 52.4 vs forecast 51.8
Fed rate cut expectations dip amid rising inflation worries
Updates to morning US trading
By Chuck Mikolajczak
NEW YORK, March 2 (Reuters) - U.S. Treasury yields shot higher on Monday as a jump in oil and gas prices after military strikes in Iran by the U.S. and Israel, followed by counter-strikes by Tehran across the Middle East, raised worries about escalating inflation.
The U.S.-Israeli air war against Iran expanded with no end in sight, with Israel attacking Lebanon in response to strikes by Hezbollah, and Tehran firing missiles and drones at Gulf states and a British air base as far away as Cyprus.
In the first formal Pentagon briefing since the campaign began, Defense Secretary Pete Hegseth declined to set out a time frame to end the mission after U.S. President Donald Trump said the air campaign could last weeks.
"At this point, oil is going to be a problem, obviously gas is going to be a problem, so that will probably delay some kind of Fed cut going forward," said Tom di Galoma, managing director at Mischler Financial Group in Stamford, Connecticut.
"As far as the run-up that we saw in the last couple weeks, a lot of it was due to the fact that people sort of felt that after the Olympics and after the State of the Union, that there was going to be some kind of movement into Iran because the negotiations weren't going right."
Expectations for a rate cut from the Federal Reserve at its June meeting - which the market had been pricing in as the first with a more than 50% chance for a cut of at least 25 basis points - dipped to 46.9% from 57.4% in the prior session, according to CME's FedWatch Tool.
Oil prices rose as much as 13% but have since pared gains, with U.S. crude CLc1 up 5.71% to $70.90 a barrel and Brent LCOc1 at $78.16 per barrel, up 7.19% on the day.
The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, rose 8.8 basis points to 3.467% and was on track for its biggest daily gain since October 29.
Yields extended gains after the Institute for Supply Management (ISM) said its manufacturing PMI was little changed at 52.4 last month compared with 52.6 in January, the second straight month above the 50 level which indicates expansion. Economists polled by Reuters had forecast a 51.8 reading.
In addition, the ISM showed a measure of prices paid by factories for inputs rose to the highest level in nearly 3-1/2 years, further fanning inflation concerns.
The yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB rose 7.6 basis points to 4.038%, on pace for its biggest daily rise since December 1.
The yield on the 30-year bond US30YT=TWEB rose 5.5 basis points to 4.688%.
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 56.9 basis points.
The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities $(TIPS)$ US5YTIP=TWEB was last at 2.483% after closing at 2.439% on Friday.
The 10-year TIPS breakeven rate US10YTIP=TWEB was last at 2.267%, indicating the market sees inflation averaging about 2.3% a year for the next decade.
(Reporting by Chuck Mikolajczak, additional reporting by Amanda Cooper in London and Rae Wee in Singapore. Editing by Hugh Lawson and Mark Potter)
((charles.mikolajczak@tr.com; @chuckmik.bsky.social))
