| LONDON, June 16
LONDON, June 16 Top-rated euro zone bonds pushed
higher on Monday as concerns over escalating violence in Iraq
supported safe-haven government debt though gains were limited
ahead of the U.S. Federal Reserve's policy meeting this week.
Financial markets were rattled after Sunni insurgents seized
a mainly ethnic Turkmen city in northwestern Iraq on Sunday
after heavy fighting, solidifying their grip on the north after
a lightning offensive that threatens to split Iraq.
German Bund futures, rose as much as 29 ticks on
the day to 145.74 with yields on 10-year Bunds, the benchmark
for euro zone lending, 2 basis points lower at 1.36 percent
. Yields on other top-rated euro zone bonds were
down by a similar amount.
"The geopolitical risk (from Iraq) is the main factor
supporting core govvies (government bonds) but I don't think it
will go far as we have the FOMC meeting looming which means
markets will be a bit cautious," said KBC strategist Piet
"The market is positioned for a rather dovish interest rates
path going forward so there are some risks the Fed will try to
make the market less complacent."
The Fed wraps up its two-day policy meeting on Wednesday and
is expected to keep steadily reducing its massive bond-buying
stimulus by $10 billion per month with investors keen for any
hints on when it might begin raising interest rates.
Any hints the U.S. central bank might hike rates earlier
than the market anticipated could lead to higher bond yields,
though the impact on euro zone bonds will be tempered by the
European Central Bank's recent policy easing measures.
Bunds continued to outperform their U.S. Treasuries, with
the two-year U.S. T-note yield premium over German counterparts
at its highest in seven years at 43 basis points, highlighting
the divergence in money policy between the Fed and the ECB.
Bunds also outpaced UK gilts after Bank of England Governor
Mark Carney stunned markets by saying rates could rise sooner
than financial markets expect.
Traders were also looking at developments in euro zone money
markets after the overnight bank-to-bank lending Eonia rate
fixed at a fresh record low on Friday surplus cash in
the banking system is set to jump this week.
The amount of cash euro zone banks have beyond what they
need for their day-to-day operations and the ECB
slashing its overnight deposit rate below zero a week ago are
key factors holding short-term rates near zero.
The surplus cash is expected to rise this week above 200
billion euros, from just over 112 billion euros, when the ECB
stops withdrawing cash to neutralise the effect of the bond
purchases it made at the height of the debt crisis.
Many in the market expect Eonia to fix in negative territory
this week for the first time ever - effectively meaning some
banks will pay to lend other banks their cash overnight - but
some said it might be short-lived as sustained negative rates
would drive out money market funds.
"Low short-rates for too long could be a harmful environment
for money market funds and unsecured lending volumes could
suffer, increasing the fragmentation (in the euro zone banking
system)," Nordea strategists said in a note.
(Editing by Toby Chopra)