Long-Term Rates Rise as ECB Shrinks Faster

The July 2026 global financial environment was defined by simultaneous rises in yields across the United States and Europe, led by the long- and ultra-long-term segments. According to data published by FRED, the U.S. 30-year Treasury yield rose to 5.210% (+35bp month on month), while the 10-year yield rose to 4.680% (+30bp), both substantially more than the 2-year yield’s +13bp increase. In the euro area, the entire curve shifted upward following the ECB’s June increase in the deposit facility rate from 2.00% to 2.25%, and the deposit facility rate–2Y gap widened again to -46bp. On the liquidity side, the FRB’s total assets were virtually flat at +0.04% month on month, whereas the ECB’s total assets fell 2.83%, the largest monthly contraction this year. The asymmetry in the pace of balance sheet normalization has become even more pronounced.

Interest-Rate Environment Across Three Regions: Levels and Direction

In July, yields rose across all maturities in both the United States and Europe, with larger increases at longer maturities. This indicates that financial tightening began in the long end rather than in short-term interest rates.

In the United States, the 10-year yield reached its highest level of the year, while the 30-year yield moved above 5%. The 10-year yield was up 42bp from 4.260% in January 2026. Combined with the 2-year yield’s increase from 3.520% to 4.230% (+71bp) over the same period, this confirms that the entire curve has shifted upward and toward greater flattening. However, the monthly move in July was led by the long end, indicating a change in direction.

Regarding the U.S. policy rate, the latest Fed Funds rate available in the FRED data is 3.640% in January 2026, so the policy rate–2Y gap cannot be calculated for July. If the policy rate had remained at its January level, the 2-year yield at 4.230% would have been approximately 59bp above the policy rate, implying that markets were pricing in a tightening bias. The gap in January was +12bp—with the policy rate above the 2-year yield, indicating expectations of gradual rate cuts—so market policy expectations may have reversed over the past six months. However, if the policy rate itself had been raised during this period, the interpretation of the gap would change. The resumption of data updates is a key point to monitor.

According to ECB statistical data, euro-area AAA-rated government bonds rose to 2.713% at 2 years and 3.201% at 10 years. The 2-year gap relative to the 2.25% deposit facility rate was -46bp, widening by 23bp from -23bp in June. This indicates that markets had begun to price in additional tightening again. The gap remains narrower than the level in the -60bp range seen from March to April, meaning that tightening expectations have not returned to their spring peak.

For Japan, July JGB yields were not included in the data provided, so comparisons of levels are not possible. The latest available data are from January 2026. Based on the spread table, the 10-year yield was 2.247%, the 2-year yield was 1.251%, and the policy rate–2Y gap was -52bp. This was the most negative gap among the three regions, indicating that markets had already been pricing in continued BOJ normalization at that time.

So What: July’s tightening occurred through two different channels: a policy-rate change in the euro area and a rise in long-term yields without a policy-rate change in the United States. The former was central-bank-led, while the latter was market-led. Because tightening is progressing from different parts of the curve in different regions, financial conditions cannot be assessed solely by the level of policy rates.

Comparative Analysis of Yield-Curve Shapes

The yield curves in all three regions exhibited a common pattern: a rise in Level and an increase in Slope, or bear steepening. However, the underlying composition differed between the United States and Europe.

The U.S. Slope recovered from 0.280% in June—the lowest level of the year—to 0.450%. The 2-year yield rose only 13bp, compared with increases of 30bp for the 10-year yield and 35bp for the 30-year yield, producing a pattern in which the increase was larger at longer maturities. The move is consistent with an expansion in the term premium required to hold long-term bonds. However, the data provided do not include an estimate of the term premium, so this factor decomposition cannot be verified numerically.

As an alternative interpretation, the rise in the 10-year yield could reflect higher expectations for future real growth or inflation. However, the limited increase in the 2-year yield indicates that expectations of near-term policy-rate increases have not strengthened substantially. If the expectations channel were dominant, the short- and medium-term segments should have reacted more strongly. The shape of the July data is therefore difficult to explain solely through the expectations channel.

The euro-area Slope rose only marginally, by 4.2bp, and was effectively close to a parallel shift led by Level. The ECB’s June rate hike pushed up the short end, with the long end following to a similar extent. The difference between the United States, where the move was market-led, and the euro area, where it was policy-led, is reflected in the composition of the curve movements.

On a year-to-date basis, the U.S. Slope has narrowed from 0.740% to 0.450%, while the euro-area Slope has declined from 0.854% to 0.488%. Both remain within a broader narrowing trend. There is not yet enough evidence to determine whether July’s widening was a temporary reversal or a turning point. The key threshold will be whether the Slope remains above 0.450% from August onward.

Excess Liquidity and the Balance Sheets of the Three Central Banks

Central-bank balance sheets showed a clear asymmetry: the FRB was broadly flat, while the ECB contracted rapidly.

The FRB had continued to expand gradually by between +0.40% and +0.66% from February onward, but was virtually flat in May (+0.07%) and July (+0.04%). This can be characterized as a neutral state in which the pace of expansion has slowed, rather than a balance sheet contraction phase involving QT. The ECB has contracted in every month since February except April, when it rose by +0.87%; July’s -2.83% was the largest decline of the year. A dual tightening—through higher interest rates and balance sheet contraction—is under way in the euro area.

Caution is required when interpreting the combined balance. The total in the data provided rose from $13.34 trillion in June to$16.9 trillion in July, but this discontinuity resulted from the BOJ monetary base of ¥5,592,039 hundred million being added to the aggregate beginning in July; it does not indicate an expansion of liquidity. On a consistent FRB-plus-ECB basis, using an approximate EUR/USD conversion of 1.08, the total declined from $13.34 trillion in June to$13.16 trillion in July, a decrease of approximately 1.4%. Global excess liquidity contracted in July when measured in dollar and euro terms.

The U.S. money supply is accelerating. According to FRED data, U.S. M2 rose to $23,290 billion, up 6.43% year on year, compared with +5.07% in June. This was more than 2 percentage points above the +4.22% increase at the start of the year. However, this is a year-on-year annual rate, while the FRB’s total assets increased 0.04% month on month; the reference periods differ. The two figures cannot be directly juxtaposed to conclude that credit creation has accelerated. The appropriate conclusion is limited to confirming separately that U.S. M2 growth has accelerated year on year, while the monthly pace of FRB balance sheet expansion has slowed. Euro-area M3 was last available at +3.44% in January, so a July comparison is not possible. Japan’s M2 is available only as a July level of ¥12,964,426 hundred million; its year-on-year change cannot be calculated.

So What: In the United States, long-term yields rose clearly even though no updated policy-rate data were available and the pace of central-bank balance sheet expansion had merely slowed. July’s defining feature was that tightening in financial conditions was concentrated at the long end of the curve. In contrast, the euro area tightened through both policy rates and the balance sheet, shifting the curve upward broadly from the short end through the long end.

Cross-Regional Spreads and Divergence

The U.S.–Europe interest-rate differential diverged by maturity, widening at the long end while narrowing at the short end.

The U.S.–Europe 10-year spread of 1.479% was the widest of the year and had widened for five consecutive months from 1.256% in March. At the long end, the yield advantage of dollar-denominated assets strengthened, creating an incentive for capital flows from euros into dollars. Meanwhile, the 2-year spread narrowed by 10.6bp. Because the ECB’s rate hike pushed up the short end, the cost of short-term carry trades funded in euros has increased.

This divergence is not contradictory. The short end is governed by actual policy-rate movements, while the long end reflects a combination of the expectations channel and risk premia; the two can therefore move in response to different factors. In July, the ECB moved the short end while the U.S. market moved the long end, producing spread changes in opposite directions depending on maturity. For hedged investors, the narrowing short-term rate differential reduces the attractiveness of dollar assets, while for unhedged investors, the widening long-term differential is supportive. This is an environment in which capital flows can become segmented by investor type.

Data on the U.S.–Japan and Japan–Europe spreads have been unavailable since February 2026, so the July yen carry-trade environment cannot be assessed quantitatively from interest-rate differentials. As of January, the latest available reference point, the U.S.–Japan 10-year spread was 2.013% and the Japan–Europe 10-year spread was -0.656%. Since the U.S. 10-year yield was up 42bp from January in July, the U.S.–Japan spread would have widened further if Japanese long-term yields had not risen by a similar amount. However, this cannot be confirmed because of the missing JGB data.

Relationship with the Inflation Environment

Japan’s CPI continued to decelerate, indicating an inflation environment moving in the opposite direction from the global rise in long-term yields. According to data from the Statistics Bureau of Japan, June 2026 headline CPI rose 1.7% year on year, core CPI rose 1.6%, and core-core CPI rose 1.7%. This was a substantial slowdown from October 2025, when headline CPI rose 3.0% and core-core CPI rose 3.1%.

• Headline CPI rose 0.2 percentage points from +1.5% in May, confirming a pause in the deceleration
• Core-core CPI fell consistently from +2.4% in March to +1.9% in April, +1.8% in May, and +1.7% in June
• The difference between headline CPI and core-core CPI was 0.0 percentage points, eliminating the divergence between underlying inflation and headline inflation

The fact that core-core CPI has remained below 2% weakens the case for the BOJ to rush into additional tightening. In contrast, the ECB raised rates in June, and markets were pricing in additional tightening through a deposit facility rate–2Y gap of -46bp. Inflation and policy directions in Japan and Europe have diverged. If this divergence persists, the Japan–Europe interest-rate differential is likely to widen again. However, the July Japan–Europe spread cannot be confirmed because of missing data.

Consistency with the Real Economy

The Cabinet Office’s Composite Indexes of Business Conditions indicate that the Japanese economy is maintaining an expansionary trend. The June 2026 Coincident Index rose to 118.2 from 117.9 in May, reaching its highest level of the year. The Leading Index was 116.4, unchanged from May, while the Lagging Index rose to 112.3.

The movement of the Leading Index is particularly noteworthy. After rising from 112.5 in January to 116.1 in April, it leveled off at 116.4 in May and June. This is a sign that the momentum of the expansion may be reaching a plateau. A combination in which the Coincident Index reaches a new high while the Leading Index stalls is typically observed when the economy is approaching a peak.

The resilience of the real economy and the slowdown in core-core CPI to 1.7% may appear contradictory. However, inflation tends to lag the output gap, and the slowdown from the 3% range in the second half of 2025 may partly reflect the fading of import-cost pressures. Strength in the real economy and slowing inflation can coexist when time lags and the composition of the factors are taken into account. For Japanese long-term yields, robust growth creates upward pressure while slowing inflation creates downward pressure, producing a tug-of-war.

Corporate Sentiment

The BOJ’s Q2 2026 Tankan Survey showed a two-layer structure: improvement in current conditions but greater caution about the outlook. The business conditions DI for large manufacturers was 22, up 5 points from 17 in Q1. This marked the fourth consecutive quarterly improvement from 14 in Q3 2025.

The outlook DI for large manufacturers was 14, implying an 8-point deterioration from current conditions. This gap widened sharply from Q1, when the DI declined only 2 points from 17 to 15. It indicates that companies have begun to anticipate a deterioration in the business environment more strongly. The direction is consistent with the global funding environment in July, when the U.S. 30-year yield moved above 5% and the ECB shifted toward rate increases.

The DI for small and medium-sized manufacturers was 9, showing steady improvement from 1 in Q3, but the gap with large companies remained at 13 points. The fact that the outlook is deteriorating while the size-based gap remains suggests that differences in corporate resilience during a period of rising global interest rates could become a future point of divergence.

Japan’s External Position

According to Japan’s trade statistics published by the Ministry of Finance, the trade balance recorded a surplus of ¥306.0 billion in November 2025 and ¥94.8 billion in December, reversing three consecutive monthly deficits from August through October: -¥294.1 billion in August, -¥277.7 billion in September, and -¥242.9 billion in October. Exports reached ¥10,407.7 billion in December, the highest level in the latest six months.

However, the available data extend only through December 2025, so Japan’s external balance as of July 2026 cannot be confirmed. As of six months earlier, the structural supply and demand for yen had improved from a source of downward pressure toward a more neutral position. The rising trend in exports is consistent with the improvement in the Tankan DI for large manufacturers.

The carry-trade environment cannot be assessed quantitatively because July U.S.–Japan interest-rate differential data are unavailable. Qualitatively, the slowdown in Japan’s core-core CPI to 1.7% reduces the urgency of BOJ tightening, while rising U.S. long-term yields increase the appeal of investing in dollar assets funded in yen through a wider long-term interest-rate differential. The reversal of the trade balance into surplus supports yen supply and demand, so the two factors work in opposite directions.

Outlook and Risk Scenarios

Base Case

The global financial environment remains characterized by tightening led by the long end. There are three reasons:

• The ECB deposit facility rate–2Y gap of -46bp indicates that additional tightening is being priced in, leaving room for euro-area short-term rates to rise
• The ECB’s -2.83% monthly change in total assets was the largest contraction of the year, indicating an acceleration in balance sheet tightening
• U.S. M2 growth of +6.43% year on year was the highest of the year, showing that the growth of the U.S. money stock is accelerating

The United States has a mixed liquidity environment: the pace of central-bank balance sheet expansion has slowed while money-stock growth has accelerated. Long-term yields have nevertheless risen. With no updated policy-rate data available, the concentration of tightening at the long end of the curve is the defining feature of the U.S. environment in July.

Risk Scenarios

Scenario 1: Further rise in U.S. ultra-long-term yields. If the U.S. 30-year yield rises an additional 50bp from July’s 5.210%, the U.S.–Europe 10-year spread of 1.479% would widen further, encouraging greater concentration of capital in the dollar. If the rise in long-end yields becomes synchronized across regions, it would also place upward pressure on the euro-area 10-year yield of 3.201% and on the long end of the JGB curve.

Scenario 2: Continued ECB balance sheet contraction. If the -2.83% pace continues for several months, euro-area reserves would decline rapidly. If funding conditions in the euro short-term money market tighten, the 2-year yield of 2.713% would rise further and the narrowing of the U.S.–Europe 2-year spread of 1.517% would accelerate. This could reduce the profitability of hedged dollar-asset investment and create a channel through which euro-area investors repatriate funds into euro assets.

Scenario 3: Reacceleration of inflation in Japan. If core-core CPI returns from 1.7% to the 2% range, expectations of BOJ normalization would strengthen. The policy rate–2Y gap of -52bp in January represented the strongest pricing of tightening among the three regions. If this gap widens again, pressure to unwind yen carry trades would emerge. Combined with the cautious outlook indicated by the Tankan DI for large manufacturers at 14, this could create a risk of simultaneous rises in Japanese long-term yields and deterioration in corporate sentiment.

Watch Points

• Update of U.S. Fed Funds rate data: Establish the policy rate–2Y gap after July and determine whether the 2-year yield at 4.230% reflects tightening expectations or simply follows the policy rate
• U.S. 10Y–2Y Slope: A sustained move above 0.450% would indicate that bear steepening is becoming established, while a return toward 0.280% would indicate a return to the flattening trend
• Monthly change in ECB total assets: Use the following month’s data to determine whether -2.83% was a one-off factor or the starting point of an accelerated contraction
• Japanese core-core CPI: Any reversal from 1.7% will affect BOJ policy expectations and the carry-trade environment
• JGB yield data: Restore the U.S.–Japan and Japan–Europe spreads to enable a quantitative assessment of the yen carry-trade environment after July

The central issue highlighted by the July data is that tightening in financial conditions is progressing from different segments of the curve in different regions. In the euro area, the central bank is leading tightening through both policy rates and the balance sheet. In the United States, by contrast, long-term yields alone have risen amid a slowdown in the pace of central-bank balance sheet expansion and simultaneous acceleration in money-stock growth. As long as this asymmetry persists, a framework that evaluates global financial conditions solely by the level of policy rates will be insufficient.

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Data Sources

• Source: Federal Reserve Bank of St. Louis (FRED), https://fred.stlouisfed.org/
• Source: European Central Bank, Statistical Data Warehouse
• Source: Ministry of Finance, Japan Government Bond Yield Information
• Source: Bank of Japan, Time-Series Data
• Source: Ministry of Finance, Japan Trade Statistics; Statistics Bureau of Japan, Consumer Price Index; Cabinet Office, Composite Indexes of Business Conditions; Bank of Japan, Tankan Short-Term Economic Survey of Enterprises

Glossary

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This column was automatically generated by AI integrating data from the Federal Reserve Bank of St. Louis (FRED), the European Central Bank (ECB) Statistical Data Warehouse, Japan Ministry of Finance, and Bank of Japan statistics as a global fiscal and liquidity analysis resource. This is not a recommendation to buy or sell any financial instruments. Please make investment decisions at your own responsibility and consult professionals as needed.