TREASURIES-US bonds drift higher in choppy trade as markets weigh Middle East risks

* Trump's unclear stance on Middle East war fuels inflation fears

* Iran, Oman drafting protocol on Strait of Hormuz traffic

* Fed rate-cut expectations fade after worrisome inflation data

* Focus shifts to US payrolls report for March (Adds comment, US data; updates yields)

By Gertrude Chavez-Dreyfuss

NEW YORK, April 2 (Reuters) - U.S. Treasuries recouped early losses to trade modestly higher on Thursday, as investors weighed comments by President Donald Trump that dampened hopes for a quick end to war in the Middle East against news that Iran could be moving to reopen the Strait of Hormuz.

Trump's much-anticipated address to the nation late on Wednesday offered little clarity on when the U.S. conflict with Iran might wind down and, crucially, waved off any responsibility for reopening the strait. Roughly 20% of global oil supplies - about 20 million barrels per day - passes through the waterway.

The speech drove oil prices sharply higher and heightened fears that inflation would rule out easier monetary policy.

"If the conflict turns into a prolonged one, the focus turns to growth even if you do have these inflationary pressures. And we have actually seen that, ... with a slight chance of rate cuts priced back in," said Chip Hughey, managing director of fixed income at Truist Wealth in Richmond, Virginia.

"The decline on the longer portion of the curve reflects the idea that sustained inflationary pressures would ultimately slow growth, not just in the U.S., but globally."

Treasury yields, which rise when prices fall, started to drift lower in the New York session, as buyers stepped in upon seeing better entry levels.

The slide in yields accelerated after Iran said it was drafting a protocol with Oman to monitor traffic in the Strait of Hormuz, a move that analysts said could pave the way for reopening the waterway. Iranian Deputy Foreign Minister Kazem Gharibabadi said the protocol would not mean restrictions, but rather would be a way to facilitate and ensure safe passage for ships that pass through.

In afternoon trading, benchmark 10-year yields were down 1.6 bps at 4.305%, after an earlier rise triggered by Trump's speech. For the week, 10-year yields have fallen about 13 bps, on pace for their largest weekly drop since the week of February 9.

MORE AGGRESSIVE ACTION

Trump on Wednesday vowed more aggressive strikes on Iran and suggested the war could escalate if leaders in Tehran did not give in to U.S. terms during negotiations, with strikes on Iranian energy and oil infrastructure possible.

That threat sparked a jump in Brent and U.S. crude futures, which were last up 7.3% at $108.57 per barrel and 11.3% higher at $111.45, respectively. The surge in oil prices also led the market to drastically reduce its outlook for Federal Reserve rate cuts this year to 7 basis points, compared with 50 basis points of easing expected before the war began on February 28.

On the shorter end of the curve, the two-year yield , which reflects rate expectations, was down slightly at 3.796%. So far this week, U.S. two-year yields have declined by 12.2 bps, on track for their biggest weekly fall since late July 2025.

The near closure of the Strait of Hormuz has snarled global supply chains for products ranging from gasoline and natural gas to jet fuel, fertilizer, chemicals, aluminum, pharmaceuticals and cement.

The inflationary wave is already being felt, with the average cost of gasoline topping $4 a gallon in some U.S. states and the wider effect still to be felt.

The jump in inflation will make it harder for the Fed to countenance a rate cut even as rising energy costs act as a tax on consumers and a drag on domestic demand.

Much now depends on Friday's release of the U.S. nonfarm payrolls report for March. The consensus forecast of economists polled by Reuters is for a gain of 60,000 jobs last month. The country shed 92,000 jobs in February.

Ahead of the payrolls number, jobless claims data on Thursday indicated stable labor market conditions, with new applications for U.S. unemployment benefits unexpectedly falling in the latest week to 202,000.

In other pockets of the bond market, the yield curve was little changed on Thursday, with the gap between two-year and 10-year yields at 51.3 bps.

The curve earlier showed a bull-flattening scenario as a result of long-term yields falling faster than those on the short end, but that reverted towards unchanged after news about a potential reopening of the Strait of Hormuz. (Reporting by Gertrude Chavez-Dreyfuss; Additional reporting by Wayne Cole in Sydney; Editing by Mrigank Dhaniwala, Paul Simao and Edmund Klamann)