Strategy commentary cont'd: Government bond markets sold off sharply across all major regions as investors grappled with the combination of stronger energy prices, elevated inflation and shifting central bank expectations. The geopolitical backdrop repeatedly pushed yields higher and flattened curves during the month, although the market reaction to each fresh escalation became progressively more muted as investors grew accustomed to the pattern.

In the US, a weak non-farm payrolls print early in July and subsequently softer CPI and PPI data, with headline CPI unexpectedly declining in June to leave annual inflation at 3.5%, pushed expectations for the next Fed rate increase further out.

The underlying inflation pulse nevertheless remains uncomfortably strong: six-month annualised core PCE is running at 3.8%, a clear acceleration on the 3.3% twelve-month rate and nearly double the Fed's target, with three of the last four monthly prints holding at that pace and inflation now above the 2% goal for more than five consecutive years. Our Taylor Rule modelling implies the policy rate should be a further 75 to 100 basis points above the current 3.50–3.75% range.

Against this backdrop, Fed Chair Kevin Warsh left his target interest rate range unchanged in a 9-3 decision, with three FOMC members dissenting in favour of a 25bp hike. Warsh concurrently abolished forward guidance by declining to offer any hints on the future rate path. The result was a sharp bear-steepening of the US curve: the 2-year yield, the purest read on near-term policy, actually fell 4bps to 4.24% on the day, while the 10-year jumped to 4.68% and the 30-year spiked as much as 14bps to 5.23%—its highest level since 2007—before finishing the month around 5.27%.

While much of the commentariat framed the sell-off as a credibility warning for the new chairman, we would offer a different interpretation: Warsh appears to be deliberately weaponising the bond market to do his tightening for him. In America, the long end—not the cash rate—is the key transmission mechanism, with households fixing 30-year mortgages (now 6.66%, the highest in a year) and corporates terming out debt across the long curve. By sounding hawkish, maximising policy uncertainty and eschewing guidance, Warsh has engineered materially higher nominal and real yields across the curve—an outcome he explicitly claimed authorship of, observing that while the Fed had done little between meetings, the markets "have done quite a bit", describing the move as "a change for the better", and adding that "we're just getting started".

Crucially, the tightening has been delivered with inflation expectations intact: 10-year breakeven inflation rates sit at just 2.28%, with the sell-off decomposing almost entirely into higher real yields (around 2.4% at the 10-year tenor, a genuinely restrictive level) and rising term premia—the Fed's Kim-Wright estimate of the 10-year term premium reached 0.73% in July, while the New York Fed's ACM measure turned positive this year for the first time since 2023. This is real tightening with credibility intact. With the political calendar arguably constraining action ahead of the November mid-terms, futures price roughly 37bps of tightening by the December meeting, which looms as the first realistic window for the Fed to move.

Notwithstanding that late steepening, yields finished July substantially higher. The 10-year US Treasury yield increased 27bps to 4.73%. German 10-year Bund yields climbed 35bps to 3.21%, their highest level in more than a decade, while 10-year UK Gilt yields rose 29bps to 5.05%. French OAT yields increased 35bps to 4.00% and Italian BTP yields rose 39bps to 4.02%. Japanese 10-year government bond yields increased another 11bps to 2.79%, leaving them 124bps higher than a year earlier. French sovereign spreads were essentially unchanged against Bunds at 79bps, while the BTP/Bund spread widened 4bps to 81bps.

Central bank guidance varied across jurisdictions. The ECB left rates unchanged, as expected, although President Lagarde revealed that some governors had considered whether another hike was warranted, which reinforced expectations for a September increase. The Bank of Japan also maintained a hawkish tone, having lifted its policy rate to 1.00% in June, whereas the Bank of England was more dovish, with Governor Bailey pushing back against suggestions that the Bank was necessarily moving towards another hike.

Japan attracted particular attention late in the month after the yen weakened to a 40-year low of ¥163.7 against the US dollar. Japan intervened on 30 July, followed by a coordinated yen-buying operation with the US Treasury on the final trading day—the first joint US-Japan intervention to support the yen since 1998. The move reversed the currency's slide, with the yen finishing July as the strongest G7 currency: USD/JPY declined 3.2% to 157.40. The euro also appreciated against the US dollar, increasing 0.9% to 1.153.