July 21 (Reuters) - Shorter-dated U.S. Treasury yields eased

on Tuesday, as hopes of a diplomatic breakthrough between the

United States and Iran pushed oil prices lower, supporting

expectations that the Federal Reserve would not need to hike

interest rates imminently.

The yield on the 2-year note, which closely tracks

expectations for Federal Reserve monetary policy, was down 1.7

basis points at 4.198%, easing after three straight sessions of

increases.

Tehran received a proposal from mediators for a 10-day ceasefire

although the decision by the Iran-aligned Houthis to impose a

naval blockade on Saudi Arabia on Monday risked further

escalating the conflict, keeping Brent crude just below $90 a

barrel, a five-week high.

U.S. inflation expectations have steadily eased this month

even as oil prices remained elevated, with a market-based

measure of one-year-ahead inflation falling

below the Fed's 2% target for the first time since October 2024.

"Despite the recent rally in oil prices, market-based measures

of inflation have stayed well anchored," strategists at ANZ

Research said in a note, adding that the Fed's credibility in

inflation management, receding tariff effects, and a

non-inflationary labour market were among several factors that

explained the stability.

"This may be indicating that monetary policy is restrictive."

Two-year yields have fallen more quickly than those for

benchmark 10-year debt, an indication of investor belief that

the Fed is under less pressure to raise rates.

Data last week showed U.S. consumer prices increased at a slower

pace than anticipated in June, prompting investors to rein in

their bets on interest rate hikes.

Money markets largely expect the Fed to keep rates unchanged

at 3.5%-3.75% at its July 28-29 meeting and have priced in a

near 66% chance of a quarter-point hike by September.

The U.S. Fed is in a blackout period before its policy

meeting next week and the U.S. economic calendar is light this

week.

The benchmark U.S. 10-year yield was little

changed at 4.598%.

With so much focus among investors on the outlook for

inflation right now, an auction of inflation-linked debt later

in the week could attract scrutiny.

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.