(Adds context in 7th paragraph, updates yield curve, milestone

for 10-year yield)

*

US 10-year yield hits lowest since mid-December

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US two-year yield falls to lowest since December 12

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US two/10-year curve flattens, narrowest gap since

December 23

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US Treasury keeps auction sizes unchanged in refunding

statement

By Gertrude Chavez-Dreyfuss

NEW YORK, Feb 5 (Reuters) - U.S. Treasury yields

declined to multi-week lows on Wednesday, weighed down by a weak

report on the services sector, with investors continuing to

grapple with persistent uncertainty about President Donald

Trump's tariff policy and the prospect of trade wars.

Trump's proposal for the U.S. government to take over war-torn

Gaza and create the "Riviera of the Middle East" after

resettling Palestinians elsewhere fueled confusion and global

criticism and sparked safe-haven bids for Treasuries.

"Trump's proposal to take over Gaza has triggered flight to

safety trades," said Will Compernolle, macro strategist at FHN

Financial in Chicago. "That comment creates the risk of

escalating a wider regional conflict."

Further adding to Wednesday's bond-bullish environment was the

U.S. Treasury's refunding announcement that showed no auction

increases in notes and bonds through the April quarter, as

expected. But its impact was felt by what it did not say.

The Treasury, which has kept auction sizes unchanged since

August 2023, did not provide guidance on when they will increase

them. Treasuries showed little reaction to the refunding

statement, although did contribute to yields staying lower on

Wednesday, analysts said.

With steady debt auction sizes for the next several

quarters, the bond market would be able to absorb the supply of

new Treasuries smoothly.

An increase in debt supply in a situation in which the

biggest bond buyer - the Federal Reserve - will not be there to

backstop the market could lift Treasury yields further, analysts

said.

The benchmark 10-year yield dropped to its lowest since

mid-December. It was last down 8.9 basis points (bps) at 4.426%

, its biggest daily fall since late January. U.S.

30-year yields sank 10 bps to 4.649% after earlier

falling to its lowest since December 18.

On the short end of the curve, the two-year yield also

tanked, sliding to its weakest since December 12. It last

changed hands at 4.187%, down 2.7 bps.

The drop in yields came after data showed the U.S. services

sector activity unexpectedly slowed in January.

The Institute for Supply Management's (ISM) non-manufacturing

purchasing managers index (PMI) slipped to 52.8 last month from

54.0 in December. Economists polled by Reuters had forecast the

services PMI edging up to 54.3.

The ISM data offset a fairly strong U.S. private sector jobs

report. Private payrolls increased by 183,000 jobs last month

after an upwardly revised 176,000 rise in December. Economists

polled by Reuters had forecast private employment advancing by

150,000.

TARIFFS AND TRADE WARS

The risk of tariffs and trade wars, however, remains a

lingering market threat, even though noise on those fronts has

eased a bit.

"The trade war is the recent thing driving yields," said

Kathy Jones, chief fixed income strategist at Schwab in New

York. "We've had the big threat of tariffs and that hasn't

really materialized, at least for the moment ... But it's really

a day-by-day, a minute-by-minute assessment of the outlook."

The uncertain outlook on tariffs came as the U.S. trade deficit

widened sharply in December. Imports surged to a record high

amid the backdrop of tariff threats.

The trade gap increased 24.7% to $98.4 billion, the highest

since March 2022, from a revised $78.9 billion in November, data

showed. The rise was the largest since March 2015. Imports, on

the other hand, increased 3.5% to a record $364.9 billion.

The United States posted significant deficits with several

trade partners, including China, Mexico and Canada, which have

been targeted by Trump for broad or additional tariffs. Trump on

Monday suspended 25% tariffs on Mexican and Canadian goods until

next month.

An additional 10% levy on goods from China went into effect

on Tuesday. China, the world's second-largest economy, slapped

duties on U.S. goods as well, although they will not take effect

until February 10.

In other parts of the bond market, the yield curve

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

hitting 23 bps, from 29.5 bps in the previous

session.

Wednesday's curve hit its narrowest spread since December

23, with traders describing it as a bull flattener, a scenario

in which long-term rates are falling faster than short-dated

ones. The curve flattening reflects concerns about growth and

inflation that could prompt the Fed to hold interest rates

unchanged for longer.