Long-dated euro zone bond yields fall with Fed rate hike priced in

LONDON: Long-dated euro zone bond yields fell on Wednesday ahead of a U.S. Federal Reserve meeting which investors expect to deliver the first rate hike in 12 months and at the same time flag its stance for 2017.

Whereas a hike in rates would normally push yields higher, on this occasion it is fully priced in and the market is focusing on what direction Fed Chair Janet Yellen will take.

"We do not rule out the possibility that the FOMC tightens with a dovish twist and downgrades the assessment of the policy stance in the FOMC statement," ING strategist Martin Van Vliet said.

The yield on Germany's 30-year bonds led the falls, dropping 5 basis points to 1.10 percent. German 10-year yields fell 2 bps to 0.33 percent.

Dutch, French and Austrian 30-year yields were down 3-4 bps.

"Investors took advantage of low valuations ahead of the up-coming U.S. key-rate decision to pile into government bonds," DZ Bank strategists said in a note. "Above all, long-dated paper was sought after in this environment."

Yields fell in other parts of the curve as well, extending Tuesday's move. ING strategists say the rally over the last two sessions is a delayed reaction to the European Central Bank's extension of its bond-buying scheme, announced last week.

Though the ECB said it would buy 60 billion euros of assets a month from April 2017 onwards, compared with 80 billion currently, it extended the programme to the end of 2017. Market expectations were for a six-month extension to September 2017.

Italian government bonds held around one-month lows after interim Prime Minister Paolo Gentiloni won an initial vote of confidence in the lower house of parliament overnight, although he is expected to face a sterner test in the upper house.

The yield on Italy's 10-year government bond edged lower to 1.87 percent, well off Monday's high of 2.13 percent.

Italian debt has been under pressure since Matteo Renzi quit as prime minister last week after a referendum defeat, putting an ailing banking sector into sharp focus.

But this week the market has taken heart from the formation of the interim government and positive developments in the country's banking sector.