Updated in New York afternoon time

By Karen Brettell

NEW YORK, July 21 (Reuters) - Benchmark 10-year U.S. Treasury yields reached a two-month high on Tuesday as escalating tensions in the Iran conflict sent oil prices higher and added to bets that the Federal Reserve will hike interest rates this year.

Oil prices climbed about 2% on Tuesday to a five-week high, on worries that energy supply disruptions could worsen in the Middle East due to more attacks between the U.S. and Iran and a threatened naval blockade of Saudi Arabia by Yemen's Houthis.

Traders are now weighing whether the renewed spike in oil prices will feed through to consumer prices and raise the odds of further Federal Reserve interest rate hikes.

Energy prices are now higher than they were at the June Fed meeting, when the majority of the committee was projecting rate hikes, said Michael Lorizio, head of U.S. rates and mortgage trading at Manulife Investment Management.

“With the repricing that we've seen in oil and gas and the dovish shift that we saw after the last Fed meeting, we have to maybe revisit some of the thinking that was in place before the de-escalation in Iran,” Lorizio said.

Inflation expectations had fallen after the U.S. and Iran reached a ceasefire deal in mid-June, and eased further after data last week showed consumer price inflation moderated more than expected in June. Those expectations are now climbing off their lows as the conflict intensifies once again.

The 2-year note US2YT=RR yield, which typically moves in step with Fed interest rate expectations, rose 4.65 basis points to 4.262%.

The yield on benchmark U.S. 10-year notes US10YT=RR rose 3.41 basis points to 4.632% and reached 4.640%, the highest since May 20.

The yield curve between 2- and 10-year notes US2US10=TWEB flattened to 36.9 basis points.

The Fed held interest rates steady at its June 16-17 meeting, but policymakers signaled they expect to raise borrowing costs later this year amid growing concern that inflation remains lodged above the central bank's 2% target.

The U.S. central bank is expected to hold rates steady again when it wraps up its two-day meeting on July 29, though traders continue to bet on a hike later in the year. Fed funds futures currently show 71% odds of a rate increase by September and an 88% probability of one by year-end.

A Reuters poll published on Tuesday, by contrast, showed that the median forecast of economists is for the Fed to keep its key interest rate steady for the rest of 2026.

Meanwhile, President Donald Trump unveiled 50% tariffs on a wide range of imports from Canada on Monday in response to what the U.S. administration called its discriminatory treatment of American-made cars, alcohol and dairy goods, threatening a new front in a global trade war.

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