Updated in New York morning time

By Karen Brettell

NEW YORK, July 22 (Reuters) - Benchmark 10-year U.S. Treasury yields climbed to a two-month high on Wednesday as rising oil prices stoked concerns that renewed energy disruptions stemming from the escalating conflict with Iran could reignite inflation and increase the odds of Federal Reserve interest rate hikes.

The resurgence of tensions in the Iran war has pushed inflation worries back into focus, following a brief lull after a ceasefire deal was reached in late June.

Oil prices surged to a near six-week high on Wednesday as U.S. Secretary of State Marco Rubio said Iran is not serious about negotiating an end to the conflict, as the widening war threatens to disrupt two of the world's most critical energy chokepoints.

The Fed is increasingly being viewed as leaning hawkish after policymakers signaled at their June 16-17 meeting that they expect to raise borrowing costs later this year.

Adding to that view, Fed Governor Christopher Waller said last week that the central bank may need to raise interest rates "in the near term" if incoming data show inflation running well above the 2% target.

“Waller had a hawkish shift in tone, with an emphasis that was totally independent of energy pass-through,” said Will Compernolle, macro strategist at FHN Financial. “That set a new anchor for a hawkish policy trajectory that had nothing to do with how the war evolved.”

Fed funds futures traders currently see just a 26% chance of a rate hike when the central bank concludes its two-day meeting on July 29, but they are pricing in 71% odds of an increase by September and an 88% probability of one by year-end.

U.S. Treasury yields have also been pushed higher by rising gilt yields, driven by fiscal concerns as Andy Burnham takes over as British prime minister.

“The focus is on fiscal worries in Europe,” Compernolle said, adding that “there's just a general sell-off in global sovereign debt.”

The 2-year note US2YT=RR yield, which typically moves in step with Fed interest rate expectations, rose 1.12 basis points to 4.272%.

The yield on benchmark U.S. 10-year notes US10YT=RR rose 1.03 basis points to 4.638% and reached 4.655%, the highest since May 20.

The yield curve between 2- and 10-year notes US2US10=TWEB was at 36.4 basis points.

Inflation expectations have climbed as well. Breakeven rates on five-year Treasury Inflation-Protected Securities rose to 2.31% — implying investors expect annual inflation of 2.31% over the next five years — after dipping to 2.21% on June 24. US5YTIP=RR

Real yields, which strip out expected inflation, also moved higher, with 10-year TIPS yields reaching 2.375% on Wednesday, their highest level since the "tariff tantrum" of April 2025. US10YTIP=RR

The Treasury Department will sell $13 billion in 20-year bonds on Wednesday and $21 billion in 10-year TIPS on Thursday.