Updates to afternoon New York trading

By Chuck Mikolajczak

NEW YORK, June 1 (Reuters) - U.S. Treasury yields advanced on Monday but were off their earlier highs, as investors looked for clarity surrounding any peace talks between the United States and Iran, which fueled an increase in oil prices.

Yields rose sharply earlier in the day after Iran's Tasnim news agency said Tehran's negotiating team was stopping exchanges of messages with the United States through mediators due to attacks on Lebanon, as diplomatic efforts to end the three-month-old Iran war continue.

However, yields eased as U.S. President Donald Trump said in a Truth Social post that talks with Iran were ongoing, countering the earlier report. Trump also said he spoke with Iran-aligned Lebanese militia group Hezbollah through intermediaries and secured a pledge that it would not attack Israel.

U.S. crude CLc1 rose 5.39% to $92.07 a barrel and Brent LCOc1 rose to $94.95 per barrel, up 4.2% on the day.

The yield on the benchmark U.S. 10-year Treasury note US10YT=TWEB rose 2 basis points to 4.473% after climbing to 4.518% on the day.

The market had a strong reaction as it had been growing optimistic an agreement could be reached between the U.S. and Iran, said Jim Barnes, director of fixed income at Bryn Mawr Trust in Berwyn, Pennsylvania.

"Today's announcement is in a category of a commentary that contradicted that," he said.

Yields fell last week on cautious optimism progress was being made towards a peace agreement between the U.S. and Iran, which pushed oil prices down to their lowest level since mid-April.

The yield on the 30-year bond US30YT=TWEB fell 0.4 basis points to 4.989% after earlier climbing to 5.028%.

MANUFACTURING DATA BEATS FORECASTS

Yields briefly extended gains after the Institute for Supply Management said its manufacturing PMI advanced to 54.0 last month, the highest reading since May 2022 and above the 53.0 estimate of economists polled by Reuters, from 52.7 in April.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes US2US10=TWEB, seen as an indicator of economic expectations, was at a positive 42 basis points.

Separately, the Commerce Department said construction spending rose 0.4% after a downwardly revised 0.2% increase in March and compared with forecasts for a 0.2% gain.

"Today's economic data is going to be overshadowed by the increased tension between Iran and the U.S.," said Barnes.

The two-year US2YT=TWEB U.S. Treasury yield, which typically moves in step with interest rate expectations for the Federal Reserve, gained 3.7 basis points to 4.051% after hitting 4.09%, its highest since May 22.

The persistently high crude prices as the Strait of Hormuz has remained closed have altered market expectations for the Fed this year. Markets are now pricing in a 53.4% chance for a hike of at least 25 basis points at the central bank's December meeting, up from about 45% in the prior session according to CME FedWatch, after pricing in roughly two cuts at the start of the year.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) US5YTIP=TWEB was last at 2.55% after closing at 2.53% on Friday, its lowest close since March 4.

The 10-year TIPS breakeven rate US10YTIP=TWEB was last at 2.413%, indicating the market sees inflation averaging about 2.4% a year for the next decade.