TREASURIES-US bonds?advance on optimism over possible US-Iran talks

* US-Iran talks in Islamabad may resume, calming oil markets

* US PPI up less than expected; little impact on bond market

* Fed rate cut expectations fade, yield curve flattens (Adds new comments, updates yields)

By Gertrude Chavez-Dreyfuss

NEW YORK, April 14 (Reuters) - U.S. Treasuries firmed on Tuesday, lifted by optimism that the Iran war could wind down soon, though trading remained subdued as investors consolidated holdings and awaited clearer developments on the conflict.

The United States and Iran could resume talks in Islamabad this week to end the war, sources told Reuters on Tuesday, after the collapse of weekend negotiations prompted U.S. President Donald Trump to order a blockade on Iranian ports.

While the U.S. blockade drew an angry response from Iran, signs that diplomatic engagement might continue helped calm oil markets, pushing benchmark prices below $100 on Tuesday.

Brent crude futures settled at $94.74 per barrel, down 4.6%. U.S. West Texas Intermediate crude also settled lower on the day, down 7.87% at $91.28 a barrel.

"Everything is still in wait-and-see mode, but we do have a little bit of optimism in the market right now. It's obvious that both the U.S. and Iran want to have some conclusion to this, and they're working towards that," said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania.

"Before, it seemed as if they were both trying to get the upper hand to some extent, and that's where the uncertainty kept increasing. Now, that uncertainty has somewhat dissipated and the market is finding comfort that a deal is going to be reached at some point," Barnes said.

In afternoon trading, the benchmark 10-year yield, which moves inversely to the price, was down 4.3 basis points at 4.254%. U.S. 30-year yields fell 3.3 bps to 4.867% .

On the shorter end of the curve, the two-year yield, which reflects interest-rate expectations, also dipped, down 3.2 bps at 3.747%.

David Rolley, co-head of the Global Fixed Income Team at Loomis Sayles, said he was a little more pessimistic about the end of the Iran conflict.

"There seems to be a disconnect, not so much about the volumes that are impacted by the closure of the Strait of Hormuz, but the market expectation for the duration of the conflict," Rolley said.

"I was thinking about the Ukraine-Russia war. When it launched in 2022, the baseline forecast was that we're not going to be talking about in 2026, four years later. But here we are."

COOLER-THAN-EXPECTED PPI

Data showing a lower-than-expected increase in U.S. producer prices for March had little impact on Treasuries, as investors remained more attuned to geopolitical developments in the Middle East.

The Producer Price Index (PPI) for final demand rose 0.5% last month after a downwardly revised 0.5% gain in February, data showed. Economists polled by Reuters had forecast the PPI accelerating 1.1% after a previously reported 0.7% gain in February.

In the 12 months through March, the PPI advanced 4.0% after increasing 3.4% in February. A Reuters poll forecast showed a year-on-year increase of 4.7%.

"This PPI report shows inflation isn't gaining momentum - it's being influenced by external shocks," Gina Bolvin, president of Bolvin Wealth Management Group in Boston, wrote in emailed comments.

"Underneath that, core inflation is relatively steady, which suggests the broader economy isn't overheating. That split is what makes this moment tricky. It leaves the Fed in a holding pattern-unable to ignore higher headline inflation, but also hesitant to react to what looks like a temporary, supply-driven move."

Following the PPI data, U.S. rate futures have priced out expectations of an interest rate cut by the Federal Reserve this year, factoring in just 7 bps of easing, compared with about 55 bps before the Iran war, according to LSEG estimates.

Another 13 bps of rate declines are implied next year, LSEG data showed.

In other pockets of the bond market, the U.S. yield curve flattened on Tuesday, with the gap between two-year and 10-year yields at 50.3 bps, compared with 51.7 bps late on Monday.

The curve exhibited a bull-flattening move as a result of long-term yields falling faster than those on the short end. Falling long-term yields sometimes signal investor concern over a downturn in the economy. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Will Dunham and Deepa Babington)