Confident Fed pulls euro zone bond yields higher, overshadows Iran worries

LONDON - European bond yields edged higher on Wednesday following a climb by benchmark short-dated U.S. yields to a near-decade high, as investors focused on a confident U.S. Federal Reserve rather than fresh geopolitical concerns.

U.S. bond yields initially fell across maturities after U.S. President Donald Trump's announcement on Tuesday that the country would withdraw from the international nuclear deal with Iran.

But that drop was short-lived as expectations grew that the Fed would raise interest rates at least three more times this year, pushing U.S. bond yields to fresh highs in early European trade on Wednesday.

That sell-off dragged euro zone 10-year bond yields up 1-2 basis points.

"A confident Powell is putting upward pressure on the short-end of the U.S. yield curve and that is cascading through the entire global bond market complex," said Ciaran O Hagan, head of euro area rates strategy at Societe Generale in London, referring to U.S. Federal Reserve chief Jerome Powell.

Yields on two-year U.S. Treasury debt rose by two basis points from the previous session to their highest levels since September 2008, pushing yields on equivalent German debt up by half a basis point to minus 0.575 percent.

The Fed has already raised interest rates six times since December 2015 when it began withdrawing its extraordinary policy stimulus put in place after the 2008 global financial crisis. Money markets have whittled down the odds of an interest rate hike from the European Central Bank by June 2019 to 75 percent.

The Fed's interest rate hikes may not pose as big a risk for global financial markets and emerging market economies as many have thought, the U.S. central bank's chairman said on Tuesday, comments that the market widely saw as a sign that the Fed was unlikely to soften its policy stance.

Still, overall moves were subdued in cautious trade as there was an undercurrent of caution evident in global markets after Trump's decision injected fresh uncertainty, with the euro well on the back foot after falling to a late-December low and stock markets broadly mixed.

"I would have expected a bit of a safe-haven bid this morning," said Benjamin Schroeder, rates strategist at ING.

"There is still an interim period before sanctions kick in. And other signatories and Iran want to keep the deal going so there is a period where things could be hammered out."

Italian bonds nursed losses after yields posted their second-biggest daily rise this year on Tuesday by 10 basis points. Benchmark ten-year Italian debt settled at a six-week high of 1.87 percent, up nearly one basis point on the day. (Reporting by Dhara Ranasinghe and Saikat Chatterjee Editing by Andrew Heavens)