* Two-year yield spikes on soft auction, last at 3.944%

* Yields higher as Iran war persists

* 10-year yield last up to 4.419%

(Updates throughout with latest market activity)

By Matt Tracy

WASHINGTON, March 24 (Reuters) - U.S. Treasury yields

rose on Tuesday after an auction of two-year notes met

underwhelming demand, as market uncertainty persists around the

Iran war and elevated oil prices.

Two-year yields edged higher following the

auction, reaching a session high of 3.963%. They previously

climbed to their highest since July in Monday trading, and were

last up 11.3 basis points at 3.944%.

The Treasury Department on Tuesday auctioned $69 billion in

two-year notes. The sale's bid-to-cover ratio, a key indicator

of demand, came in at roughly 2.45x and was below the average

range of 2.5x to 2.6x.

"The (two-year) sector has been a decided underperformer in

the Treasury market since the beginning of the war in the Middle

East, selling off by as much as 63 bp from pre-war levels on

Monday," BMO rates strategists wrote on Tuesday.

Yields inched higher in morning trading as optimism over a

quick easing of the Middle East crisis faded, renewing concerns

about inflation risks.

The benchmark 10-year Treasury yield was last up 8.3

basis points at 4.419%, but short of a near eight-month high

touched on Monday.

Yields had dipped on Monday from their multi-month highs after

U.S. President Donald Trump said he had delayed strikes on

Iranian power plants and energy infrastructure, following what

he called productive talks with Iran.

But Iran's foreign ministry responded shortly after that

there was "no dialogue" between Tehran and Washington, according

to state-affiliated media. Iran then announced fresh attacks on

U.S. targets, lifting crude oil prices.

Major brokerages have revised their 2026 average oil price

forecasts as the war rages on and disruptions in shipments from

the Strait of Hormuz persist, with Goldman Sachs raising its

Brent crude oil forecast for 2026 to $85 a barrel from $77.

"You're seeing energy prices up today, which is driving a

lot of the move back up in yields," said Jan Nevruzi, U.S. rates

strategist at TD Securities. He added that five-year

and seven-year Treasury notes had similarly edged

higher on elevated energy prices.

Five-year yields were last up 10.5 bps to 4.055%, while

seven-year yields were last up 9.8 bps at 4.241%.

A closely watched part of the U.S. Treasury yield curve

measuring the gap between yields on two- and 10-year Treasury

notes, viewed in the market as an indicator of

economic expectations, was last at 46.95 basis points.

U.S. rate futures on Friday began to price in the possibility of

an interest-rate hike later this year after the Fed and other

central banks last week kept rates on hold. Markets last priced

in a 89.7% chance of no hike for the Fed's April meeting,

slightly lower than in the morning.

Data on Tuesday showed U.S. manufacturing and services business

activity fell to an 11-month low in March.