By Min Zeng

Demand for haven bonds jumped Wednesday as U.S. political jitters drove investors to shed risk appetites, sending the yield on the benchmark 10-year Treasury note below 2.3% again.

The buying pushed down the 10-year yield to 2.247%, down sharply from 2.329% Tuesday. Yields fall as bond prices rise.

Other haven assets also gained ground, ranging from government bonds in Germany and the U.K., gold and the Japanese yen. The U.S. dollar dropped more than 1% against the yen, a large move for this liquid currency pair, underscoring investors' anxiety.

The catalyst for the latest round of flight to safety was reports late Tuesday on the revelation that President Donald Trump allegedly asked then-FBI Director James Comey to back off the investigation of former national security adviser Michael Flynn, which prompted some congressional Republicans to call for further investigation. In a statement issued Tuesday evening, the White House denied the account.

"It is all about Trump," said Thomas Roth, executive director in the rates trading group at MUFG Securities Americas Inc. "The dollar is tanking as the world loses confidence in the U.S.'s sorry state of affairs."

The development followed Mr. Trump's surprise decision a week ago to fire Mr. Comey. Investors are concerned that this political uncertainty is likely to make it more difficult for Mr. Trump to push through his ambitious fiscal agenda.

Mr. Trump's campaign promises of lower taxes, large infrastructure spending and lighter regulations have been the key factor driving investors to bet on stronger economic growth and higher inflation. Theso-called Trump trade has been highlighted by investors selling Treasurys and buying securities such as stocks, corporate bonds, the dollar and emerging-market assets.

In essence, the allocation reflects investors' optimism that expansive fiscal policy would give the economy a strong boost at a time when the Federal Reserve has been tightening monetary policy and giving the economy less support than in recent years.

Confidence on the Trump trade has been waning over the past few months as investors are less confident that Mr. Trump would be able to deliver a tax overhaul and other stimulus soon. The latest political drama surrounding his presidency injects a fresh layer of uncertainty toward the fiscal outlook.

"The headlines do suggest the difficulty of marshaling support for a prosaic legislative agenda when such sensationalist headlines are sucking up all the oxygen and creating all-consuming news cycles," said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.

The bond market has been flagging a pullback of the Trump trade. After a big rise late last year, the 10-year Treasury yield has been falling this year. It was 2.446% at the end of 2016.

There is "some further room for yields to fall in a more significant escalation of the current scandal, especially if it threatens to blunt efforts to reach a compromise between and within the current congressional caucuses," said Mr. Lyngen.

Some traders say Treasury yields are likely to post a steep drop if anxiety is heightened toward whether Mr. Trump might face impeachment.

"The worst cases scenario of an actual impeachment, although still far-fetched, is picking up steam," said Anthony Cronin, a Treasury bond trader at Société Générale SA. "This brewing crisis is likely to keep a decent bid to Treasurys."

The slides of Treasury bond yields have also been driven by a number ofdatapoints over the past month that raised some questions over the U.S. growth momentum.

There are some signs that inflation is easing, which stoked demand for Treasurys. The consumer-price index -- excluding food and energy -- last month fell below the Fed's 2% target for the first time since 2015. Inflation chips away bonds' fixed returns over time and is seen by many as a big threat to long-term government bonds.

The question now is whether the political news out of D.C. might affect the Fed's tightening plan.

The Fed is on track to raise short-term interest rates in June after a boost in March. The labor market is approaching full employment, financial conditions remain loose, and the weakness in the U.S. dollar give the Fed some room to tighten policy.

But market expectations toward a rate increase in June dialed back Wednesday, though they still show a high probability for the Fed to act. Fed-funds futures, used byinvestors to bet on the Fed's monetary-policy outlook, showed a 69% chance that the central bank would raise short term interest rates by its June 13-14 meeting, according to CME Group. The measurement was 74% on Tuesday.

Analysts say high expectations of a rate increase next month reduces the risk of a big selloff in the bond market. Some caution that the Fed could make a policy error given the uncertainty about the U.S. growth outlook and with inflation showing some signs of deceleration.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

May 17, 2017 11:07 ET (15:07 GMT)

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