May 17, 2017 / 8:12 AM / 2 months ago

UPDATE 3-Trump troubles push U.S. and German bond yields closer

4 Min Read

* Gap between U.S.-German yields narrowest in six months

* Euro zone yields follow US Treasuries lower on Trump worries

* Tumult in White House dents Fed rate hike bets

* German and French bond sales supported by integration hopes (Rewrites top, updates prices)

By John Geddie

LONDON, May 17 (Reuters) - The gap between U.S. and German government borrowing costs reached its narrowest in more than six months on Wednesday as a tumultuous week at the White House contrasted with a sense of improved political stability in Europe.

The scandals embroiling U.S. President Donald Trump boosted demand for safe haven assets globally, but though most euro zone bond yields fell on Wednesday, the move was sharpest in U.S. Treasuries.

Reports this week that Trump may have tried to interfere with a federal investigation and that he discussed sensitive security information with Russia have fuelled concern among investors that he may be distracted from pushing through economic stimulus plans.

These fears have even started to dent firm expectations that the U.S. Federal Reserve will raise interest rates next month.

The euro zone is no stranger to political upheaval, but with a number of countries having fended off far-right and eurosceptic challenges in votes this year, there appears to be a renewed sense of unity within the bloc.

"At the moment, everyone is focusing on the political relief in Europe and the political unrest in the U.S.," ING's senior rates strategist Martin van Vliet said.

U.S. 10-year yields dropped 8.5 basis points on Wednesday to an almost four-week low of 2.243 percent while German equivalents were 5 basis points lower at 0.38 percent . At 187 bps, the gap between the two benchmarks was the lowest since Nov. 14.

This gulf was also evident in currency markets, with the euro climbing to its highest since Nov. 9 against the dollar.

In a further sign of confidence in European markets, bids at an auction of German 30-year debt on Wednesday were more than double the amount offered, while France on Tuesday gathered 31 billion euros of orders for a bond in the same maturity.

Divergence

Coupled with a string of disappointing economic data, the U.S. political uncertainty has reduced expectations for a U.S. rate hike in June from over an 80 percent chance last week to below 70 percent on Wednesday, according to CME's FedWatch tool.

Meanwhile in Europe, new French President Emmanuel Macron and German Chancellor Angela Merkel on Monday agreed to draw up a roadmap to deeper European Union integration and opened the door to changing the bloc's treaties to facilitate ambitious reform.

Spain added its voice to calls for deeper integration on Tuesday.

Although other political tests will come in Germany, Austria and possibly Italy later this year, for now investor attention has shifted to the outlook for monetary policy.

Many analysts expect the ECB to scale back its bond-buying quantitative easing scheme by the end of the year, and to signal its intent possibly as soon as next month. They expect interest rate rises to follow in 2018. (Editing by Jeremy Gaunt)

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