By Sunny Oh

Impending Italian election uncertainty boosts haven German bund

Treasury prices rose, pulling yields lower, on Friday after the Federal Reserve, in a report to Congress, gave little indication it plans to raise interest rates more aggressively in 2018.

Trading was typified by wild swings throughout the week as monetary policy concerns and inflation fears kept bond-buyers on edge.

What are bonds doing?

The 10-year Treasury note yield was down 4.6 basis points to 2.871%, contributing to a weeklong decline of 0.5 basis point, according to data from WSJ Market Data Group. The yield hit a four-year high at 2.957% on Wednesday.

The 2-year note yield fell 0.8 basis point to 2.242%, but nevertheless rose 4.9 basis points for the week. The 30-year bond rate fell 4.7 basis points to 3.158%, helping to trim the weeklong climb to 2.2 basis points.

Bond prices move in the opposite direction of yields.

What's driving markets?

Federal Reserve Chairman Jerome Powell is set to deliver semiannual testimony before the House Financial Services Committee on Tuesday. In its monetary policy report, the Fed did not appear to be in favor of pressing the pedal beyond the three rate increases expected in 2018. That helped to extend the bond market's rally by tamping down on fears that the central bank would go in overdrive in response to resurgent inflation.

Read: Fed on track for 3 rate hikes in 2018, but 4? No sign in report to Congress (http://www.marketwatch.com/story/fed-on-track-for-3-rate-hikes-in-2018-but-4-no-sign-in-report-to-congress-2018-02-23)

U.S. bond prices initially rose after traders looked ahead to the Italian election on March 4 where the chance of a populist euroskeptic party being elected caused Italian debt to come under pressure and bonds of other eurozone economies to surge. In particular, German bonds, or bunds, received a lift thanks to its role as the traditional haven asset in European markets.

Treasurys tend to follow bunds as they share similar characteristics and are both seen as high-quality and liquid assets.

Analysts and the latest polls indicate the most likely result from the election is a hung parliament. The potential for political deadlock threatens the prospect of economic reforms needed to resuscitate Italian growth and a banking system weighed down by bad debts. Italy's government debt as a percentage of GDP stands above 130%, the second highest levels in the eurozone.

See: Why investors are counting down to the most important date on Europe's political calendar (http://www.marketwatch.com/story/investors-are-counting-down-to-the-most-important-date-on-europes-political-calendar-2018-02-20)

(http://www.marketwatch.com/story/investors-are-counting-down-to-the-most-important-date-on-europes-political-calendar-2018-02-20)In a quiet week for economic data, the 10-year yield made an attempt to break toward the 3.00% level, a key psychological level, on Wednesday after the prospects of an aggressive Federal Reserve coupled with fears over a deluge of fresh issuance sent rates higher. In addition, the minutes from January's meeting of the Federal Open Market Committee raised the outlook of inflation to scare off holders of long-dated debt, the most sensitive to the corrosive effects of higher prices.

What did analysts' say?

"Both the Minutes and the Monetary Policy Report reflected more optimism about the economy and reduced insecurity about attaining the inflation mandate and expectations for a series of rate hikes in 2018," said Ward McCarthy, chief financial economist for Jefferies, in a note.

"The story of higher Treasury yields has in part been driven by the recent barrage of news related to Treasury supply. Besides the passage of the $1.5 trillion tax package on December 20 of last year, there have been a number of other catalysts on the Treasury supply front that have played a role in moving yields higher," said analysts at Wells Fargo Securities.

What else is on investors's radar?

New York Fed President William Dudley, Cleveland Fed President Loretta Mester, Boston Fed President Eric Rosengren spoke during the University of Chicago Booth School of Business Fed policy forum. Dudley (http://www.marketwatch.com/story/feds-dudley-says-balance-sheet-should-be-at-least-29-trillion-2018-02-23)said he was open to employing quantitative easing again if interest rates neared zero.

At the same forum, the Fed appeared to receive pushback from Wall Street. Investment bank economists presented a paper suggesting the Fed's bond-buying program wasn't as stimulative as investors might have thought, and that the central bank's reduction of its asset purchases would therefore not lift yields as much as expected.

Read: Good news--the Fed's shift to quantitative tightening might not be as painful as expected (http://www.marketwatch.com/story/good-news-the-feds-shift-to-quantitative-tightening-might-not-be-as-painful-as-expected-2018-02-23)

Bond investors are concerned that without the backstop of the central bank, the wave of issuance coming this year may only draw bond-buyers who desire a discount and higher yields.

How did other assets' move?

The yield for the 10-year German government bond, or bunds, fell 5.2 basis points to 0.653%. But the 10-year Italian government bond yield only fell by 0.7 basis point to 2.067%, to pare back the weeklong climb.

(END) Dow Jones Newswires

February 23, 2018 16:42 ET (21:42 GMT)