For next ECB taper clues, euro zone bond markets look to the Fed

Euro zone government bond yields nudged down on Wednesday as investors awaited the conclusion of a U.S. Federal Reserve meeting for clues on whether another interest rate rise is likely this year.

Caught between a lull in U.S. inflation and a stronger global economy, the Fed is expected to signal whether it will raise rates for a third time this year or back off until prices rise more briskly.

What it says is important for the outlook for monetary policy in the euro zone, since any statement that points to another rate hike this year could lift the dollar against the euro <EUR=>.

And any weakening in the single currency, up around 14 percent against the dollar this year, could encourage the European Central Bank to press ahead with plans to unwind its hefty stimulus scheme.

A strong euro, with its dampening effect on inflation, has clouded the outlook for ECB tapering.

ECB policymakers are divided on whether to set a definitive end-date for their stimulus scheme when they meet in October, raising the chance that they will keep open at least the option of prolonging it again, Reuters reported on Tuesday.

“The euro is still strong so that doesn’t make life easier for the ECB,” said Commerzbank rates strategist Rainer Guntermann. “If we move closer to a U.S. rate hike, that should come along with a bit more dollar strength and euro weakness which would harden the ECB’s exit case and be a headwind for government bonds.”

Most euro zone bond yields fell around 1-2 basis points on the day.

Portugal’s 10-year bond yield hit its lowest level since December 2015 at 2.387 percent <PT10YT=TWEB>, extending sharp falls seen after the country’s return to investment grade with a major ratings agency.

German bond yields dipped after a 30-year bond auction.

Germany’s 10-year Bund yield was down 1.5 bps at 0.44 percent, while 30-year yields fell 2 bps to 1.23 percent.

Still, the main focus remained the Fed.

Expectations for a December Fed rate hike have gained ground over the past week, boosted by stronger-than-expected inflation numbers.

The Fed’s policy statement is due out at 1800 GMT. Fed Chair Janet Yellen will hold a press conference half an hour later.

“We think that another rate hike by the end of this year still has a 40 percent chance, however the upcoming economic data is going to keep traders on their toes due to the massive footprints of hurricanes,” said Naeem Aslam, chief market analyst at ThinkMarkets UK.

The Fed is also likely to announce a scheduled reduction of its approximately $4.2 trillion in holdings of bonds and mortgage-backed securities.
Source: Reuters (Reporting by Dhara Ranasinghe; Editing by Catherine Evans)