March 16 (Reuters) - German government bond yields rose on Wednesday on hopes of progress in peace talks over Ukraine while markets waited for the outcome of the Federal Reserve policy meeting.
World stocks jumped after new talk of compromise from both Moscow and Kyiv on a status for Ukraine outside of NATO and China's promise to roll out more fiscal stimulus boosted risk appetite.
"Markets are focusing on a possible solution to the Ukraine conflict, hoping there will be no escalation," Eoin Walsh, Portfolio Manager at TwentyFour Asset Management said.
"Because of that, the attention is back to what central banks might do in terms of monetary tightening with fewer tensions on the geopolitical front," he added.
Germany’s 10-year government bond yield, the euro zone benchmark, rose 6 basis points (bps) to 0.38%, after hitting its highest since November 2018 at 0.403%.
Germany sold 3.4 billion euros of 10-year Bund at a price implying an average yield of 0.38% versus 0.31 at an auction on February 16.
Two-year bond yield, more sensitive to interest rate changes, was up 6.5 bps to -0.35%. It hit its highest since September 2015 at -0.214% on February 7.
Italian bond prices outperformed their peers with the 10-year yield dropping 1.5 bps to 1.895% and the spread between Italian and German yields tightening to 150 bps.
"Expectations of joint debt issuances from the EU have recently supported Italian bond prices," Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors said.
"But today, their outperformance is more related to BTPs’ short-coverings after a recent selloff,” he added.
Italian 10-year yields jumped 30 bps to 1.9% after a hawkish shift from the European Central Bank on March 10.
Before the ECB policy meeting, the Italian-German spread tightened on expectations for debt sharing among euro zone countries and less stringent fiscal rules after the reform of the stability pact, which EU members should discuss this year.
Investors were still assessing the impact of the war in Ukraine and if risks of stagflation might trigger a more dovish stance from central banks.
"We think that ECB’s forecasts about economic growth are overly optimistic, in both the adverse and severe scenario," TwentyFour Asset Management's Walsh argued.
ECB Vice-President Luis de Guindos and policymaker Joachim Nagel played down risks of stagflation.
The Fed, which will end its policy meeting later in the day, is expected to step up the fight against inflation with the first of a series of rate hikes this year.
Money markets continue to price in about 170 bps worth of Fed rate hikes by December 2023.
But investors seem to be more focused on how the U.S. central bank plans to end its bond-buying programme and the future pace of reinvestments from maturing bonds.
"While stagflation fears are hard to dismiss and QT (quantitative tightening) could drive the policy tightening eventually, our economists expect the macro backdrop to stay sufficiently resilient to keep the FOMC going," Commerzbank analysts said in a note to clients.
(Reporting by Stefano Rebaudo, editing by Mark Potter and Emelia Sithole-Matarise)
