June 19, 2019 / 10:33 AM / 3 months ago

UPDATE 2-Calm returns to euro zone bond markets after Draghi storm

* Bond yields touch higher after Tuesday’s hefty falls

* ECB policymakers divided after Draghi speech- report

* Focus turns to Fed meeting

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Dhara Ranasinghe

LONDON, June 19 (Reuters) - Euro zone bond yields rose on Wednesday, with a degree of calm returning to markets a day after a surprise hint from ECB chief Mario Draghi of more stimulus triggered the biggest one-day fall in borrowing costs in years.

A U.S. Federal Reserve rate decision later in the day provided another reason for bond investors to pause for thought.

Ten-year bond yields across the bloc rose 3-5 basis points in what analysts described as a natural bounce after Tuesday’s aggressive market moves on Draghi’s comment that policy would be eased again if inflation failed to accelerate.

Germany’s 10-year bond yield rose 3 basis points to minus 0.29%. On Tuesday, it hit a record low at minus 0.33% and posted its biggest one-day fall since September 2016.

Tuesday saw long-dated bond yields across the euro area post their biggest one-day falls in at least a year .

And a key gauge of long-term euro zone inflation expectations reversed course, posting its biggest one-day rise on Tuesday. The five-year, five-year breakeven inflation forward rose further on Wednesday to almost 1.29%.

“Draghi essentially put the market on steroids,” said Matthew Cairns, fixed income strategist at Rabobank. “For markets, the debate now is not about whether there will be stimulus but what kind of stimulus we will get.”

Risks are tilted to the downside and if they start to materialise, the European Central Bank will take action, Vice President Luis de Guindos said on Wednesday.

News that ECB policymakers were divided, with some feeling powerless, after Draghi’s comments at an ECB conference in Sintra, Portugal, had little significant impact on a bond market positioned for more rate cuts.

Trading in euro zone money market futures point to a roughly 85% chance of a 10 bps rate cut at the ECB’s September meeting. A cut is fully priced in by October.

Some banks have shifted their calls for when the ECB, which ended its massive asset purchase scheme just six months ago, will ease policy again.

Commerzbank expects the ECB to cut rates in July, having previously anticipated a move in the fourth quarter.

Focus was also on the Fed, which concludes a two-day policy meeting later. It is expected to leave interest rates on hold but flag whether it plans to cut later this year as investors expect and the U.S. president has demanded.

Against the backdrop of a bitter trade war, the Fed and other major central banks have turned more dovish recently.

“The way the markets are looking at the trade war is that the Fed will be aggressive and do everything it can to keep the show on the road,” Karen Ward, chief market strategist, EMEA, at JPMorgan Asset Management told a conference in London on Tuesday.

“My concern is that the Fed cutting rates is not going to be enough to ease the damage of the trade wars.”

Reporting by Dhara Ranasinghe Editing by Andrew Heavens/John Stonestreet/Susan Fenton

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