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Euro zone bond markets look to the Fed

Germany’s 10-year bond yield hovered near recent five-week highs 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.

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 the 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.

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“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 were marginally higher early on Wednesday. Germany’s 10-year Bund yield stood at 0.45 percent — close to almost five-week highs hit on Monday.

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. (Reuters)

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