Euro zone bond yields little changed before Fed, traders await new catalysts

By Alun John

LONDON, June 18 (Reuters) - Euro zone bond yields eased slightly on Wednesday with traders awaiting the outcome of the Federal Reserve meeting later in the day for any hints about further rate cuts, and keeping a wary eye on developments in the Middle East.

Germany's 10-year bond yield DE10YT=RR was down nearly 4 basis points on the day at 2.497%, and its two-year yield was down 1.6 bps at 1.85%. DE2YT=RR

The big event for markets around the world on Wednesday is the Fed's rate decision, though the U.S. central bank is widely expected to leave its benchmark overnight interest rate in the 4.25%-4.50% range, where it has been since December.

Traders' focus will be on whether it gives any clues as to if and when it might begin cutting rates again, though it is also likely to repeat that it cannot give much guidance until the impact of U.S. President Donald Trump's import tariffs and fiscal policies becomes clearer.

Even an unlikely change in Fed messaging may do little to nudge European government bonds out of their recent rangebound trading, ING analysts said, as the economic effect of tariffs - inflationary in the U.S., disinflationary in Europe - means Fed and ECB policy is becoming more divergent.

Markets are currently pricing one final 25-basis-point ECB rate cut this cycle to take its terminal rate to 1.75%, expectations that have been fairly steady in recent weeks, contributing to rangebound trading in government bonds.

Michiel Tukker, senior rates strategist at ING, said there were two things that could change that.

"First is trade. July 9 is the date where we possibly have trade tariffs kick in if there isn't a trade deal. That'll start becoming a hot topic in the weeks before, and that's the period we're rolling into," he said.

"Either negotiations turn sour, we go back to 1.5% (terminal rate), or things go quite well and he (Trump) softens his narrative and we maybe go closer to 2%, or at least stay near 1.75%, and the focus will shift back to German fiscal spending."

Germany is embarking on a massive ramp up of borrowing to fund increased spending on infrastructure and defence, likely leading to higher yields in the long term.

The other factor in the near term, according to Tukker, was economic data, though it would require multiple data points to detect a clear trend given the recent volatile trade policy.

"Each data point can tell a different story depending on the sample month," he said.

Investors will also be looking at Wednesday's releases of U.S. Treasury International Capital data that shows overseas ownership of Treasuries.

There was much speculation this month that foreign investors were looking to reduce their ownership of U.S. government bonds due to erratic U.S. policy. Again, however, one data point will not be enough to provide a clear picture.

U.S. Treasury yields fell on Wednesday as concerns over the war in Iran boosted safe-haven demand for the debt.

Other bonds in Europe were largely moving in line with Germany's. Italy's 10-year bond yield, the benchmark for the euro zone periphery, was down 3 bps at 3.48%. IT10YT=RR