Euro zone yields edge lower after traders price in one ECB hike in early 2027

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Markets price in just a 5% chance of a rate cut in summer 2026

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Main driver of bond selloff is the hike premium, says Citi

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Fed could deliver some hawkish signals after the expected cut

By Stefano Rebaudo

Dec 9 (Reuters) - Euro zone government bond yields edged lower on Tuesday as investors took a breather after pricing out a European Central Bank rate cut for 2026 on Monday and indicating more than a 50% chance of a rate hike in March 2027.

A batch of strong economic data and comments from ECB policymaker Isabel Schnabel, who said a rate hike was more likely than a cut, pushed 10-year euro zone borrowing costs to multi-month highs on Monday.

That day, German 30-year yields hit their highest levels in more than 14 years, as long-dated debt came under global pressure on worries over rising fiscal spending and heavier bond supply.

"The primary driver (of the recent bond selloff) has been higher ECB hike premium," said Jamie Searle, European rate strategist at Citi, while also mentioning recent economic data, spillovers from Federal Reserve rate expectations, and the comments from Schnabel.

"We do not expect the market to run too far ahead in building ECB hike premium," he added, recalling that Citi sees the central bank stuck to a 2% key rate for a couple of years.

On Tuesday, Germany's 10-year yields, the euro area's benchmark, were down 2.5 basis points at 2.84%. They hit 2.876% on Monday, their highest since mid-March.

Markets priced in around a 5% chance of an ECB rate cut next summer, up from zero the previous day, while indicating roughly a 50% chance of a hike by March 2027, down from about 60% earlier in the session.

Jane Foley, strategist at Rabobank, mentioned as a driver of higher borrowing costs in the euro area "the possibility that ECB doves could push back on this opinion (from Schnabel) and in view of concerns that the Fed may also deliver some hawkish guidance alongside an expected rate cut this week."

"Assuming no new shocks to growth in the coming months, it is possible that the market could be increasingly focused on rate hike risks by the end of next year," she said.

Benchmark 10-year U.S. Treasuries yields were down one bp at 4.16% after rising 3.5 bps on Monday.

Investors will closely watch data from the U.S. Job Openings and Labor Turnover Survey (JOLTS) due later in the session.

They also expect the Fed to deliver a 25-bp rate cut when its policy meeting concludes on Wednesday, but the focus will be on any signals about the path ahead, with traders currently pricing in three more cuts by the end of 2026.

Germany's 30-year yields, more sensitive to long-term fiscal concerns, fell 2 bps to 3.45%, after hitting 3.478% on Monday, the highest since summer 2011. Yields on German 2-year Schatz rose one bp to 2.15%. (reporting by Stefano Rebaudo. Editing by Andrew Heavens and Mark Potter)