UPDATE 1-Core euro zone bond yields up, partially retracing steep decline
German 10-year government bond yields rose three basis points to 0.255 percent, following a five basis point fall on Thursday. The move comes ahead of a vote among Germany's Christian Democrats on who replaces Chancellor Angela Merkel as party leader.
Attention now turns to November U.S. employment data later on Friday, offering investors a temporary diversion from the brewing U.S.-China trade war, which sent stocks into a tailspin this week and sparked widespread demand for safe-haven bonds.
A strong report could allay fears about the U.S. economy's health, seal the deal for an interest rate hike later this month, and increase the probability that the Federal Reserve will raise rates more than once again next year.
"The idea that strong nonfarm payrolls could be positive for other asset classes is nullified by the recent flattening of the Treasury curve," said Peter Chatwell, rates strategist at Mizuho.
"Pressure on the front end of the curve will put it into (further) flattening mode, and the other asset classes really don't like that."
Financial markets are pricing in one rate hike from the Fed in 2019, compared with expectations for possibly two rate hikes a month earlier, according to CME Group's FedWatch program.
U.S. Treasuries rallied strongly this week, with U.S. 10-year yields falling to three-month lows as traders scaled back expectations on the number of rate hikes the Federal Reserve might be able to deliver amid weakening economic data and trade conflict.
Renewed confidence in the U.S. economy and expectations that the Fed will continue raising rates will put upward pressure on core euro zone bond yields, especially with the European Central Bank preparing to formally end its 2.6 trillion euro bond-buying programme later this month and perhaps pave the way for rate hikes of its own later next year.
ITALY EYES VOTE
Italian government bond yields fell by up to six basis points, again retracing some of the previous day's sell-off, which saw yields rise by more than 10 basis points, the biggest rise since late October.
The Italy/Germany bond yield spread was last at 287.9 basis points, having widened nearly 20 basis points on Thursday. Italy's 10-year government bond yield was six basis points lower on Friday at 3.14 percent.
Markets appeared relatively calm ahead of a possible confidence vote in parliament, where the ruling coalition has a large majority, to help accelerate the passage of the 2019 budget.
Two analysts said the vote had little bearing on the market.
"Both leading parties have a strong majority so it doesn't have an impact," said Daniel Lenz, rates strategist at DZ Bank.
However, Deputy Prime Minister Luigi di Maio had to deny that his party had called on Economy Minister Giovanni Tria to resign.
The Italian government on Thursday bought back two BTP and three CCTEU bonds worth 3.2 billion euros while swapping investors into new bonds maturing October 2021 in a bid to manage its debt stock. (Reporting by Virginia Furness; Editing by Kevin Liffey and Janet Lawrence)
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