* Trump allegations raise doubts about tax cuts, new spending
* Brazilian stock plunge boosts safety buying of U.S. bonds
* U.S. two-, 10-year yield curve flattest since October
NEW YORK, May 18 (Reuters) - U.S. Treasury yields fell on Thursday as investors worried that allegations against U.S. President Donald Trump would divert lawmakers from tax cuts and fiscal spending that they had hoped would boost growth. Yields on benchmark 10-year notes fell to one-month lows of 2.18 percent on strong buying overnight after Reuters reported that Michael Flynn and other advisers to Trumps campaign were in contact with Russian officials and others with Kremlin ties in at least 18 calls and emails during the last seven months of the 2016 presidential race. That came after the U.S. Justice Department on Wednesday named former FBI chief Robert Mueller as special counsel to investigate alleged Russian interference in the election and possible collusion between the Trump campaign and Moscow.
The risk going forward is that this thing goes on and on and we dont have a resolution, which means the new administration is not able to work on its tax initiatives and regulatory reform, said Subadra Rajappa, head of U.S. rates strategy at Societe Generale in New York. A plunge in the Brazilian stock market on concerns about political instability also added to safety buying of U.S. bonds. Newspaper O Globo reported on Wednesday that Brazilian President Michel Temer gave his blessing to an attempt to pay a potential witness to remain silent in the country's biggest-ever graft probe, according to plea bargain testimony by a powerful businessman. Brazil had been an improving fundamental situation, but which now has its own re-upped level of political risk at a time when the broad perception was that the countrys corruption problems were being addressed, said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia.
Benchmark 10-year notes were last down 1/32 in
price to yield 2.26 percent, up from 2.22 percent late on Wednesday. The yield curve between two-year notes and 10-year notes flattened to 95 basis points, its lowest since Oct. 27 as investors reached for longer-duration bonds. Longer-dated notes are viewed as having more potential upside than two-year bonds, which are highly sensitive to interest rate changes. The Federal Reserve is expected to hike rates next month. The two-year is going to be pegged to Fed expectations, so if theres a flight to quality, youre going to see that manifest in the back end of the curve," Rajappa said.
(Editing by Lisa Von Ahn)