TREASURIES-Yields drop as Trump calls off strikes on Iran

(Updated in New York afternoon time)

* Treasury yields fall after Trump halts planned military strikes on Iran

* Fed rate hike odds for December drop to 55%

* Treasury sees soft demand for 30-year bonds in auction

By Karen Brettell

NEW YORK, June 11 (Reuters) - U.S. Treasury yields fell on Thursday after President Donald Trump called off plans for renewed U.S. military strikes on Iran at the last minute, saying negotiations with Tehran had advanced to the highest levels of Iran's leadership and had been approved by a broad coalition of regional powers.

The reversal came just hours before the strikes were expected to take place. Expectations of military action had earlier pushed Treasury yields higher. But details of the diplomatic breakthrough after more than three months of war - including how Iran's leadership had signaled its approval - were not immediately clear in Trump's post on Truth Social.

Markets are likely to remain cautious until it looks clear that an agreement is finalized, said Molly Brooks, U.S. rates strategist at TD Securities.

Even if a deal is reached, the normalization of oil markets could also take several months.

"Oil futures will come down, but the actual price of oil might still be elevated. So you might still see this pass through to inflation for the next few months," Brooks said.

Traders cut the odds of a Federal Reserve rate hike this year after Trump's comments. Fed funds futures traders are now pricing in a 55% chance of a hike by December, down from 68% earlier on Thursday.

The 2-year note yield, which typically moves in step with Fed interest rate expectations, fell 5.5 basis points to 4.072%.

The yield on benchmark U.S. 10-year notes fell 7.3 basis points to 4.467%.

The yield curve between 2- and 10-year notes flattened to 39.5 basis points.

Treasuries are also being supported by demand tied to quarter- and half-year portfolio rebalancing this month, said Tom di Galoma, managing director of global rates trading at Mischler Financial Group.

Yields earlier gained after data showed that U.S. producer prices posted their largest annual gain in 3-1/2 years in May. The Producer Price Index for final demand rose 1.1% during the month, above economists' expectations for a 0.7% increase.

The Treasury saw soft demand for a $22 billion auction of 30-year bonds, the final sale of $119 billion in coupon-bearing supply this week.

The bonds sold at a high yield of 5.020%, more than a basis point above where they traded before the auction. Demand was below average at 2.33 times the amount of debt on offer.

The U.S. government saw good demand for a $39 billion sale of 10-year notes on Wednesday and average interest in a $58 billion auction of three-year notes on Tuesday.

(Reporting by Karen Brettell; Editing by Paul Simao and Andrea Ricci )