US Treasury yields shot higher on Monday after military strikes in Iran by the US and Israel, followed by counter-strikes by Tehran across the Middle East, sparked a jump in oil and gas prices and raised fears about escalating inflation.

The US-Israeli air war against Iran expanded with no end in sight, as Israel attacked Lebanon in response to strikes by Hezbollah and Tehran kept up its missile and drone attacks on Gulf states.

"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 percent chance for a cut of at least 25 basis points – fell to 45.2 percent from 57.4 percent in the prior session, according to CME's FedWatch Tool.

Oil prices rose as much as 13 percent but have since pared gains, with US crude CLc1 settling up 6.28 percent to US$71.23 a barrel and Brent LCOc1 settling at US$77.74 per barrel, up 6.68 percent on the day.

The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, surged 11.1 basis points to 3.49 percent and was on track for its biggest daily gain since June 6.

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.

In addition, the ISM showed a measure of prices paid by factories for inputs rose to the highest level in nearly 3.5 years, further fanning inflation concerns.

"For the manufacturing recovery to turn into a renaissance will require the conflict with Iran to be short-lived instead of the feared protracted quagmire," said Brian Jacobsen, chief economist at Annex Wealth Management in Menomonee Falls, Wisconsin. (Reuters)



Edited by Cecil Wong