March 21, 2018 / 8:24 AM / 5 months ago

As Fed hike looms, US/German two-year bond yield gap widest in 21 yrs

* Euro zone periphery govt bond yields

By Dhara Ranasinghe

LONDON, March 21 (Reuters) - The gap between short-dated U.S. and German government bond yields held close to its widest in 21 years on Wednesday, highlighting a divergence in monetary policy outlooks ahead of a widely anticipated rate rise from the U.S. Federal Reserve.

Two-year U.S. Treasury yields hit more than nine-year highs on Tuesday as investors bet the Fed will conclude a two-day meeting later this session by lifting interest rates for the first time this year.

While most euro zone bond yields crept higher early on Wednesday as a note of caution held sway over markets, borrowing costs remain close to multi-week lows on a view that the European Central Bank will take a slow and steady approach to unwinding monetary stimulus.

In fact, a string of dovish comments from ECB officials over the past week have seen investors push back expectations for a ECB rate rise to the second quarter of next year from the first quarter, money market pricing suggests.

With U.S. two-year bond yields close to nine-year highs at around 2.35 percent and short-dated German bonds yields mired in negative territory at minus 0.57 percent , the gap between the two was at 292 basis points — close to its widest levels since 1997.

“The euro area economy, while doing well, is still several years behind the U.S.,” said Chris Scicluna, head of economic research at Daiwa Capital Markets. “If you look at how long it took the Fed to normalise policy, one can understand why the ECB will go slowly.”

The Fed is scheduled to issue its latest policy statement at 1800 GMT.

A key focus is if Jerome Powell adopts a more hawkish tone at his first meeting as Fed chairman than predecessor Janet Yellen and whether Fed officials change their projections for future rate increases, known as the “dot plot”. “The uncertainty is higher than usual as we have Powell in front of reporters for the first time,” said DZ Bank rates strategist Christian Lenk.

Most euro zone bond yields were flat to 1 basis point higher in early Wednesday trade.

Germany’s benchmark 10-year yield was at 0.58 percent , not far off lows hit last week ahead of a auction of long-dated debt later in the session.

Reporting by Dhara Ranasinghe Editing by Catherine Evans

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