* Oil prices gain 2% on fresh US-Iran attacks and Houthi

blockade threats

* 10-year yield highest in two months

* Fed funds futures show 88% probability of rate hike by

year-end

(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 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 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

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.