March 21, 2019 / 9:33 AM / 4 months ago

UPDATE 3-German 10-year yield hurtles towards 0 pct as Fed signals rate-hike halt

* U.S. Fed forecasts no hikes in 2019

* UST yields hit 14-month lows, set tone for Europe

* German Bund yield falls to just 0.034 pct

* German yields set for biggest monthly fall since May

* Euro zone periphery govt bond yields (Updates pricing, adds Deutsche Bank on no-deal Brexit)

By Dhara Ranasinghe

LONDON, March 21 (Reuters) - Germany’s 10-year bond yield hurtled towards zero percent on Thursday, dropping to its lowest since late 2016, a day after the U.S. Federal Reserve abandoned its projections for any rate rises this year given signs of an economic slowdown.

The Fed also said it would halt the steady contraction of its balance sheet in September, in what proved to be a more dovish-than-anticipated policy meeting on Wednesday.

The news pushed U.S. 10-year Treasury yields to 14-month lows in the biggest one-day fall since Jan. 3. They touched new lows in European trade on Thursday, dragging European yields down with them.

Germany’s benchmark 10-year bond yield fell to a two-year low of just 0.034 percent, on track for its biggest one day fall since March 7 when the ECB surprised markets with its own more dovish stance.

The U.S./German 10-year bond yield gap narrowed to its tightest since mid-January and was last around 247 bps .

“The Fed couldn’t have been more Treasury market friendly short of calling the next recession and signalling rate cuts,” said John Davies, G10 rates strategist at Standard Chartered Bank in London.

“It’s fully understandable why we’re back at these levels in German Bund yields given what has happened at the Fed and with Treasury yields.”

Across the euro zone, long-dated bond yields fell as much as six basis points on the day .

“What the Fed did by shelving rate hike bets this year and ending the balance sheet reduction went further than what many had expected,” said KBC rates strategist Mathias van der Jeugt.

“More and more investors will take this as a signal that this is the end of the rate hiking cycle.”

The Fed’s policy action provided fresh impetus to a sharp fall in government borrowing costs in the euro area which was sparked by the ECB’s comments earlier this month.

French and German 10-year bond yields are down around 14 bps this month and on track for their biggest monthly falls since March and May 2018 respectively, while Ireland’s 10-year bond yield is down 18.5 percent and heading for its biggest monthly fall since February 2017.

“Given how entrenched the downtrend in the Bund yield appears to be, hitting zero percent wouldn’t be a surprise,” Standard Chartered’s Davies said.

However, he added that by being as dovish as it has been, the Fed may create conditions for a turnaround in economic growth and sentiment that could ultimately push German yields higher from here.

British 10-year yields tumbled over 10 bps to their lowest since September 2017 and were on track for their biggest monthly drop since February 2017 as fears the UK would leave the European Union without a deal rose again.

Deutsche Bank on Thursday hiked its expectation of a no-deal Brexit to 20 percent - the highest level to date - from 10 percent, as a third attempt to get UK parliamentary approval for a divorce deal looms.

British Prime Minister May has asked European Council President Donald Tusk to delay Brexit from March 29 until the end of June and said she was preparing for a third vote in the British parliament on the exit deal she arduously negotiated with the EU.

Traders are increasingly worried that should her deal fail to get parliamentary approval next week, there are few outcomes which would be positive for markets in the short-term.

Overall, banks’ probability metrics for a no-deal Brexit remain low and haven’t changed in recent days - Berenberg, for example, maintain their probability at a slim 15 percent.

Reporting by Dhara Ranasinghe; additonal reporting by Virginia Furness, and Saikat Chatterjee Editing by Mark Heinrich and Kirsten Donovan

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