Long-dated bond yields reached new highs Monday as fresh military escalation between the U.S. and Iran lifted oil prices.

The 10-year Treasury yield traded at 4.764%, on pace for its highest settlement since January 2025. The two-year yield reversed an overnight decline and edged higher, reaching 4.337%.

The moves followed revived hostilities in the Middle East that clouded the long-term economic outlook at a time when markets are bracing for an increase in interest rates by the U.S. Federal Reserve.

The U.S. attacked Iranian rocket launchers Sunday and shortly after defended against missiles launched at Jordan, raising fears of an all-out conflict. Oil prices rose around 3%, rekindling concerns about inflation.

In the eurozone, yields rose after the U.S. attack on Iran.

"The exchange was limited, but it marks the first U.S. strike on Iran's forces in more than a month and highlights the risk of renewed escalation," Sofie Liv Petry, assistant analyst at Danske Bank, said in a note.

The 10-year German Bund yield rose as high as 3.313% in European midday, a level unseen since 2011, according to LSEG data.

Volumes were thinner Monday, however, due to a U.K. bank holiday.

The hostilities found markets already adjusting to a hawkish tone struck by Fed Chairman Kevin Warsh during Friday's speech at the Jackson Hole, Wyo., symposium. He said he was impressed by the economy's performance but expressed concern about inflation remaining above target, leaving the door open to raising interest rates in the coming months.

"Rising oil prices could also revive concerns about persistent inflation, placing upward pressure on yields and strengthening the dollar if the trend persists," said Bas Kooijman, chief executive and asset manager of DHF Capital.

Investors significantly stepped up expectations for a rate increase in September following the speech. U.S. money markets Monday priced a 64% probability of a rate increase at the next meeting on Sept. 16, compared with 35% Friday before Warsh spoke, according to LSEG.

"While Warsh did not send clear signals on the timing of rate changes, the speech was supportive of market expectations of a rate hike during the fall--whether in September or by year-end," Elisabet Kopelman, U.S. economist and Fed watcher at SEB, said in a note.

At the same time, investors were relieved at the clarity Warsh offered on the outlook after he had left investors uncertain about the Fed's policy path and its commitment to tackling inflation following the central bank's meeting in July.

Warsh was "walking back his communication mistakes in July," Kopelman said.

Larry Holzenthaler, senior portfolio manager at Catalyst Funds, said Warsh "was successful in re-establishing confidence."

"He came across as very focused on inflation and bringing it back in line with the Fed's 2% target."