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updates yields)

* Trump's unclear stance on Gulf war fuels inflation

fears

* Iran, Oman drafting protocol on Hormuz Strait traffic

* Fed rate-cut expectations fade on worrying inflation

data

* Focus shifts to US payrolls report for March

By Gertrude Chavez-Dreyfuss and Wayne Cole

NEW YORK/SYDNEY, April 2 (Reuters) - U.S. Treasuries

clawed back losses to trade higher on Thursday, as investors

weighed comments from President Donald Trump that seemed to dim

hopes of an early end to the war in the Middle East while news

that Iran could be laying the groundwork to reopen the vital

Strait of Hormuz tempered some risk aversion.

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. It's also a major route for the transport of

liquefied natural gas, especially from Qatar.

The speech drove oil prices sharply higher and heightened

fears that inflation would rule out easier monetary policy.

"Trump's comments drove the moves in all assets because

there's really no clear plan presented on the timeline on the

war and how the administration is going to wrap it up," said Jan

Nevruzi, U.S. rates strategist at TD Securities. "So inflation

has become a focus again."

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 was extended on a report that Iran is

drafting a protocol with Oman to monitor traffic in the Strait

of Hormuz, which analysts said could pave the way for its

reopening.

In midday trading, benchmark 10-year yields

were down 2.8 basis points to 4.295%, falling after an earlier

rise triggered by Trump's speech. For the week, 10-year yields

have fallen about 14 bps, on pace for their largest drop since

the week of February 23.

MORE AGGRESSIVE ACTION

Trump on Wednesday vowed more aggressive strikes on Iran and

also 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 caused a jump in Brent and U.S. crude

futures, which were last up 5.2% at $106.54 per barrel

and 9% at $109.19, respectively. The surge in oil also saw the

market price out Federal Reserve interest rate cuts for

this year, compared to the 50 basis points of cuts expected

before the war began on February 28.

On the shorter end of the curve, the two-year yield

, which reflects interest rate expectations, was

slightly down at 3.794%.

The near closure of the strait has snarled global supply chains

for a host of products, including gasoline, natural gas, jet

fuel, fertilizer, chemicals, aluminum, pharmaceuticals and

cement.

The inflationary wave is already being felt, with average cost

of gasoline topping $4 a gallon in some U.S. states and the

wider effect still to be felt.

A closely watched survey of manufacturingon Wednesday showed its

measure of prices paid had shot up 19 points in just two months

to levels typically consistent with a 4% annual inflation rate.

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 the release on Friday of the U.S. employment

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.

"A rebound in job creation will likely see market pricing shift

materially in favor of a Fed hike, or two, as has been the case

elsewhere across the developed world," analysts at Westpac wrote

in a note.

In other pockets of the bond market, the yield curve

flattened, with the gap between two-year and 10-year yields

narrowing to 50.5 bps, compared to 51.2 bps late

on Wednesday.

The curve showed a bull-flattening scenario as a result of

long-term yields falling faster than those on the short end.

This situation is largely a reflection of the news about a

potential reopening of the Strait of Hormuz.