Government bond yields set for biggest monthly rise since March

Money markets indicated a more hawkish interest rate outlook on both sides of the Atlantic this month, fuelling a bond selloff and pushing yields higher as the conflict in the Middle East reignited inflation fears.

Traders returned to fully pricing a European Central Bank depo rate at 2.75% in early 2027, a level last seen at the height of the Iran conflict, while quickly scaling back expectations for Federal Reserve rate cuts.

The ECB raised interest rates to 2.25% in June before pausing this month, while the Fed has remained on hold and is expected to deliver two rate hikes by June next year, with a first move in October almost fully priced in by markets.

Elsewhere, Japan’s borrowing costs were little changed with the 10-year flat at 2.79% JP10YT=JBTC after the Bank of Japan kept interest rates steady, signalling further rate hikes.

German two-year bond yields, which are particularly sensitive to interest rate expectations, fell 0.5 basis points to 2.76% but were still on course for a 22-bps increase in July.

U.S. two-year Treasury yields were unchanged at 4.23% US2YT=RR and were set for a monthly rise of 9 bps.

Long-dated bonds underperformed in July, sending their yields sharply higher as investors began to assess the implications of a prolonged conflict in the Middle East, including the prospect of increased fiscal spending, larger budget deficits and a rising debt burden.

Germany's 10-year bond yield fell 1.5 basis points to 3.15% DE10YT=RR, but was on track for a 28-bps increase this month.

The benchmark U.S. 10-year Treasury yield US10YT=RR slipped 1.5 bps to 4.65% and was about to end July about 22.5 bps higher.