When ECB President announced in January that the central bank would not change its collateral policy at the end of 2010 for the sake of any particular country, his rigid remarks helped turn the thumb screws on Greece. And although he recently did buckle on the issue, probably as part of a broader strategy to coincide with an IMF and EU-wide bailout plan, his remark can be viewed through different spectacles. The ECB will now accept weaker collateral for the sake of many countries. The gravity of the contagion that's clearly spread to the peripheral Eurozone nations was accentuated well by fellow-member Axel Weber yesterday when he stated that the Greek fiscal crisis carried grave contagion effect for other European members.

European bond markets - There's little change in the trading tone today with core bonds higher and peripherals lower. The Spanish treasury managed to successfully auction €2.35 billion in five-year notes, admittedly at 3.53% compared to an average rate of 2.82% during the past four auctions, but it does prove the market is still breathing. A week ago ratings agency S&P reduced its rating of Spanish debt. Italian and Spanish 10-year notes yields increased by 10 basis points while the Spanish premium over comparable German debt rose to its widest on record at 139 basis points. In midweek trade the German 10-year bund yield slumped to 2.80% - its lowest in at least two decades.

After the ECB press conference today held in Lisbon bond traders again bought bunds penetrating the Wednesday peak by two pips at 126.61. The European short end is stable with little change in futures prices. With short-term rates at 1% investors have recently speculated that the ECB may ultimately counter fiscal austerity measures with an official rate reduction to offset the likely painful growth reduction in response to spending cuts.

Eurodollar futures -U.S. treasuries are higher in this environment although have rebounded from an earlier loss in the June future to 118-12. The contract is also higher on the day despite a marginal third weekly reduction in initial claims. The magic number through last weekend read 444,000 with a slight upward revision to the prior week. In the fever-pitch trading session of yesterday, 10-year yields slipped to a five-month low.

In recent weeks the firmer labor market has caused monetary policy watchers to expect a Fed tightening at some point this year. That thought provoked a sell-off in bond prices lifting yields to almost 4%. At that point the yield spread between U.S. and Germany stood at 90 basis points (U.S. above Germany). As the crisis migrates across Europe the safe haven status of the United States has forced a sharper rally for treasuries than bunds exerting a narrowing tendency on the spread, which recently slipped to 62 basis points.

Canadian bills - Canadian yields slumped to the lowest point since the end of February as the growth-sensitive currency suffered over contagion worries. Dealers will be questioning the rationale for the Bank of Canada to raise rates in this environment. Bill prices at the short end are showing a mixed performance ahead of Friday's jobs report likely to show the creation of 27,000 jobs.

Australian bills -Australian yields slumped by 12 basis points for a sharp fall after a retail sales report for March showed less than half the strength dealers expected. The news affirmed the central bank's Tuesday decision to signal a pause in monetary policy. Bill prices were seven basis points higher with cash rates sliding by an equivalent sixteenth of one percent.

British gilt - The sterling short end is flat on Election Day with futures one tick better. June gilts are also marginally higher at 117.13 carrying a yield of 3.81%.

Japanese bonds - Japanese markets reopened after a three day pause and given the turmoil, bond prices rallied sharply but lost some of the feverish run-up to close in the June contract for a seven tick gain at 139.75. The yield slumped intraday to 1.25% - its lowest since December 22, 2009. Regional stocks were weak and helped cement gains.

Andrew Wilkinson Senior Market Analyst