TREASURIES-US yields drop as tariff shock spurs flight to safety

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Investors worry about inflation, growth impact after tariffs

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Trump to delay tariffs on Mexico by a month.

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US yield curve flattens, hit narrowest gap since late December

(Adds new comment, bullets, byline, NEW YORK dateline; updates prices)

By Gertrude Chavez-Dreyfuss, Harry Robertson and Tom Westbrook

NEW YORK/LONDON/SINGAPORE, Feb 3 (Reuters) - U.S Treasury yields fell on Monday in volatile trading as investors sought cover in the safety of government debt on worries about the inflationary and growth impact of U.S. President Donald Trump's tariffs on Canada, Mexico and China.

The move in yields has flattened the yield curve, with the gap between two-year and 10-year Treasury yields hitting 24.7 basis points (bps), the narrowest gap since late December. The curve was last at 27.4 bps, compared with 33.8 bps late Monday.

Traders described Monday's yield curve as a "bull flattener", a scenario in which longer-dated rates are falling more sharply than those on the front end, reflecting a flight to safety.

Trump's 25% tariffs on Canada and Mexico and 10% tariffs on China - the United States' three largest trading partners - rocked global markets on Monday. Trump said his administration will also impose tariffs on members of the European Union, but gave no timetable.

However, Trump said on Monday he will delay tariffs on Mexico by a month following a dialogue with Mexican President Claudia Sheinbaum.

U.S. front-end yields have shuttled between gains and losses, indicating an uncertain outlook on inflation due to tariffs that could prompt a lengthy pause on rate cuts from the Federal Reserve. Treasury yields on the back end, on the other hand, fell as investors bought longer-dated debt amid fears tariffs could undermine U.S. growth.

"The market is trying to figure out what the tariffs are going to mean: are they inflationary, are they going to slow growth, are they going to cramp a Fed rate cut?," said Kim Rupert, managing director, global fixed income analysis, at Action Economics in San Francisco. "People don't know how to price so many uncertainties."

Most currencies tumbled against the dollar and European stocks and U.S. stocks fell sharply as investors assessed the potential hit to the global economy. The dollar index, which measures the U.S. currency against six peer more than 1%.

In late morning trading, the benchmark 10-year Treasury yield fell 6.3 bps to 4.504%.

U.S. 30-year Treasury yields slid 7.2 bps to 4.742%.

On the front end of the curve, two-year Treasury yields , which are particularly sensitive to Fed policy, slipped 1 bp to 4.228%.

"Rates (government bond markets) will struggle between the inflationary impact which would push rates higher and growth impact which would push them lower," said Mohit Kumar, European economist at Jefferies.

"Our view would be that the risk aversion moves dominate, but still see limited impact on rates."

The impact of the tariffs was clearer in Europe, however,

Germany's two-year bond yield, which is sensitive to expectations about European Central Bank interest rates, fell 7.2 bps to 2.042%, its lowest since the start of the year.

U.S. rate futures have priced in about 45 bps of easing this year, up from 42 bps late Friday, according to LSEG calculations, with the first rate cut likely to occur at the Fed's June policy meeting.

Tariffs, in theory, slow growth which ought to support bonds. However, they also raise prices and potentially give companies cover for further price hikes or for consumers to start to expect price rises and press for higher wages.

"Increased U.S. tariffs underscore our view 10-year Treasury yields will rise to 5% as a second Trump term boosts inflation," said, Mansoor Mohi-uddin, chief economist at Bank of Singapore, the private banking arm of OCBC Bank.

A closely watched market-based gauge of long-term U.S. inflation expectations ticked up slightly to 2.57% on Monday, from 2.55% on Friday.