TREASURIES-Yields fall as hopes of end to Iran war ease inflation fears

(Updated in New York afternoon time)

* Iran keeps Strait of Hormuz open during ceasefire

* Traders see increased odds of Fed rate cut

* Warsh faces April 21 confirmation hearing as Fed chair

By Karen Brettell

NEW YORK, April 17 (Reuters) - U.S. Treasury yields fell on Friday as optimism grew that the Iran war may be nearing resolution, easing concerns about a renewed bout of inflation. Iranian Foreign Minister Abbas Araqchi said on Friday that the Strait of Hormuz - through which a fifth of the world's oil and liquefied natural gas usually transits - was open following a ceasefire agreement in Lebanon. U.S. President Donald Trump said talks could take place this weekend and he believes a deal to end the war would come "soon." Oil prices fell by around 11% on the news.

"I think that that's what's driving the whole move," said Tom di Galoma, managing director of global rates trading at Mischler Financial Group.

"Do we actually get a prolonged ceasefire and a Strait reopening? I don't know. This seems like it's going to take some time to work itself out. But right now, I think that's what's going on. ... It's all the good news coming out of the Gulf," di Galoma said.

The 2-year note yield, which typically moves in step with Federal Reserve interest rate expectations, fell 7.6 basis points to 3.702%.

The yield on benchmark U.S. 10-year notes fell 5.9 basis points to 4.25%.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at a positive 54.6 basis points.

Fed funds futures traders are now pricing in approximately 50-50 odds of an interest rate cut by year-end, after seeing only a 30% chance of a rate reduction on Thursday, according to the CME Group's FedWatch Tool.

Oil prices had risen sharply due to war-related disruptions, stoking fears of another wave of inflation. Fed policymakers are now weighing those price pressures against signs of a softening labor market. San Francisco Fed President Mary Daly on Friday said businesses are optimistic the Iran war will be short-lived and oil prices will not stay persistently high, but she is in "wait and see" mode. Fed Governor Christopher Waller said the Iran war is likely to drive up inflation near term and creates a challenging outlook for monetary policymakers, although he said a fast end to the conflict would keep the door open to cutting interest rates again later this year.

Trump's nominee for Fed Chair Kevin Warsh, meanwhile, will face a Senate confirmation hearing on April 21. Daly said that Warsh may have plans for big changes at the U.S. central bank, but like previous Fed leaders cannot know what economic surprises he may need to deal with once he is in the role.

Warsh is expected to push for more interest rate cuts if he becomes Fed chair, replacing Jerome Powell when his term ends next month.

(Reporting by Karen Brettell; Editing by Kirsten Donovan and Will Dunham)