TREASURIES-Yields fall as oil drops, Fed uncertainty lingers

(Updates to New York afternoon time, adds market details)

* Five-year breakeven rates fell to 2.20% from 2.74% in May

* Fed funds futures traders priced a 68% chance of a September rate hike

* Markets expect Thursday's core PCE inflation report to show 3.4% annual growth

By Karen Brettell

NEW YORK, June 24 (Reuters) - U.S. Treasury yields fell on Wednesday as oil prices slid to a four-month low, while investors continued to weigh the likelihood of Federal Reserve rate hikes later this year. Brent crude prices fell 3% as supply concerns eased with more stranded oil tankers exiting the Strait of Hormuz.

"It's all driven by oil at this point," said Molly Brooks, U.S. rates strategist at TD Securities.

Five-year breakeven rates, a market-based measure of expected annual inflation over the coming five years, have fallen to 2.20% from 2.74% in May. Shorter-dated Treasury yields climbed after Fed policymakers signaled last week that they expect to raise borrowing costs later this year amid persistent inflation running above the central bank's 2% target.

Easing oil prices may relieve some inflation pressure, but elevated price levels are still keeping the Fed under pressure to tighten policy. Fed funds futures traders are currently pricing in 68% odds of an interest rate hike by September.

Thursday's PCE inflation report is expected to show core prices rose 0.3% in May, putting the annual rate at 3.4%. Headline inflation is forecast at 0.5% for the month and 4.1% year-over-year.

The 2-year note yield, which typically moves in step with Fed interest rate expectations, fell to 4.137%, the lowest since June 17. The yield on benchmark U.S. 10-year notes reached 4.398%, the lowest since May 11.

Thirty-year Treasury yields fell to 4.849%, the lowest since April 8.

The yield curve between 2- and 10-year notes flattened to 25.9 basis points.

The Fed held rates steady at its June meeting, where new Chair Kevin Warsh signaled a shift away from forward guidance by becoming the sole member to withhold his projection from the "dot plot."

Brooks said that further moves in that direction, or an outright removal of the "dot plot," could rattle markets.

"We tend to see term premium increase as well as volatility" when monetary uncertainty is high, she said, adding that markets typically price in more dovish outcomes than the median dot, meaning its removal could push rate expectations higher. U.S. Treasury Secretary Scott Bessent on Wednesday applauded Warsh's plan to reduce forward rate guidance, but said Fed policymakers need to keep an open mind on the inflation impact of the Iran conflict and productivity gains driven by artificial intelligence models. Traders are also waiting on a Supreme Court decision relating to President Donald Trump's efforts to fire Fed Governor Lisa Cook.

Demand was soft for the Treasury Department's $70 billion 5-year note auction on Wednesday, the second sale of $183 billion in short- and intermediate-term coupon-bearing debt this week. The notes sold at a high yield of 4.20%, the highest auction yield since January 2025 and almost a basis point above where they traded before the auction. Demand was 2.35 times the amount of debt on offer, the highest since December.

Demand was good for the U.S. government's $69 billion 2-year note sale on Tuesday and it will sell $44 billion in 7-year notes on Thursday. (Reporting by Karen Brettell in New York; Editing by Matthew Lewis)