In most of the world, the catalyst for the move higher in yields was a growing belief that central banks will be forced to raise rates as commodity prices soar. A euro zone report showed year-over-year CPI rose to 4.0% in June, from 3.6% in the previous month. Crude oil forced the issue as it reached another record, hitting $143.67 per barrel before pulling back to $140.41 late in the session.

The European Central Bank is widely expected to raise rates by a quarter point on Thursday but analysts are also beginning to believe they will have to hike rates again.

"The ECB is concerned that the higher the headline inflation rate goes, and the longer it stays elevated, the greater will be the danger of major second round inflationary effects occurring," said Howard Archer, chief European and UK economist at Global Insight.

In Germany, returns on two-year German bonds were up 15.3 bps to 4.60%, with five-year yields up 15.0 bps to 4.64%, 10-year yields up 9.8 bps to 4.62% and 30-year yields up 4.6 bps to 4.85%.

Yields on UK two-year bonds were up 8.6 bps to 5.23%, with five-year yields up 9.0 bps to 5.18%, 10-year yields up 9.5 bps to 5.13% and 30-year yields up 6.5 bps to 4.68%.

Yields on two-year Canadian government bonds were up 8.1 bps to 3.25%, with five-year yields up 6.5 bps to 3.46%, 10-year yields up 4.3 bps to 3.74% and 30-year yields up 1.5 bps to 4.08%. The Canadian 10-year note is yielding 21.92 bps less than the U.S. 10-year note.

At the Montreal Exchange, interest rate trading was light ahead of the Canada Day holiday on Tuesday. The September BAX contact priced in a higher probability of rate hikes as prices fell 0.04 to 96.73. Volume was at 37% of the 10-day average. Canadian government bond futures were more active - at 96% of the recent average. They were down 0.33 to 117.47.

In the U.S., yields initially ticked higher along with the rest of the world but later returned to unchanged as stocks pared early gains and worries about the financial sector arose. Those worries were magnified by an 11% drop in shares of Lehman Brothers.

U.S. two-year yields are down 1.6 bps to 2.61%, with five-year yields down 2.4 bps to 3.32%, 10-year yields flat at 3.96% and 30-year yields flat at 4.52%. The Eurodollar September 08 contract is down 1.5 ticks to 97.07. The yield curve is flatter, with the 10/2-year spread down 2.5 bps to 134.81 bps.

Traders were also reflecting on the Chicago ISM survey (formerly the Chicago PMI). It climbed to 49.6 from 48.0 in June. Also weighing on markets was the fact that Monday marked the month-end, quarter-end and half-year-end.

Canadian equity markets once again outperformed the U.S. despite a modest down day for commodities.

"The [U.S.] stock market has come around to the realization the economic outlook is deteriorating mostly because of high oil and commodity prices," said Carlos Leitao, chief economist and strategist at Laurentian Bank.

Toronto's S&P/TSX composite index closed up 112 points to 14467, the Dow Jones industrial average closed up 4 points to 11350, the S&P 500 closed up 2 points to 1280 and the Nasdaq ended the day down 23 points to 2293.

European stock markets closed in mixed territory with the Eurostoxx up 30 points to 2906, the UK FTSE 100 up 96 points to 5626 and the German DAX down 4 points to 6418.

The loonie was down against major currencies on Monday despite the release of a higher-than-expected Canadian GDP report for April. Traders say large buyers of U.S. dollars were able to drive the loonie down because of low liquidity.

Jonathan Gencher, director of FX sales at BMO Capital Markets, said the move lower in the Canadian dollar was "probably an overshoot" but warned that similar moves could take place for the rest of the week because of holidays in Canada and the U.S.

The Canadian dollar is down 0.0106 to 0.9790 against the U.S. dollar (1.0214 USD/CAD) and down 1.04 to 103.92 against the yen.

The U.S. dollar is up 0.01 to 106.15 against the yen and the Dollar Index is up 0.168 to 72.528.

The euro is down 0.0048 to 1.5746 against the U.S. dollar, up 0.0118 to 1.6083 against the Canadian dollar, down 0.0011 to 0.7905 against the pound sterling and is lower by 0.46 to 167.14 against the yen.

The pound sterling is down 0.0030 to 1.9920 against the U.S. dollar and up 0.0182 to 2.0350 against the Canadian dollar.

The front month gold contract at the Chicago Board of Trade is down $3.40 to $927.50 per ounce.

All data taken at 4:45 p.m. EDT.

By Adam Button, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Stephen Huebl, This email address is being protected from spam bots, you need Javascript enabled to view it

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