The appeal of safe haven German bunds wore thin after the ECB said it would buy bonds of Italy and Spain following an emergency weekend meeting of its governing council. Global tensions mounted after Friday's close when Standard & Poor's served up a unwelcome medicine for the United States as it took back one-of-three A-letters from the sovereign rating of the world's largest economy. Despite the fears of many gloomsters, yields on U.S. government debts fell at the opening of the week with investors more concerned on the impact of S&P's fiscal take on global growth. As a result the differential between U.S. and German costs of borrowing widened in favor of the U.S.

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Eurodollar futures - Two-year yields reached a record low at 0.24% while there was a little restraint at the 10-year with the yield falling to 2.46%. However, after the first hour of equity trading the S&P 500 benchmark index was picking up downside momentum and forcing treasury note futures to session highs. The dramatic slippage in the stock index means that the damage to the August - May rally now mounts to a retracement of more than 50%. Not only are investors disenchanted by loss of momentum from quantitative easing to the magnitude of $2.3 trillion, but they hold increasingly little comfort in current prospects now that the FOMC appears to have retired that policy. However, at this pace of frenzied breakdown, investors will be clamoring to hear what the Fed intends to do when it releases its statement on Tuesday. The slide in global growth projections are fodder for deferred Eurodollar contracts, which on Monday advanced by 14 basis points.

European bond markets - The ECB used the weekend to review the reach of its asset-purchase policy, issuing a statement penned by President Trichet on Sunday saying that in honor of the advances made by market-roiled governments towards balancing their budgets, the central bank would now buy bonds of Spain and Italy in the secondary market as it tried to reinforce sanity on market forces. The comforting move saw a massive shift lower in yields by 82 basis points for 10-year Italian debt and 91 pips for Spanish bonds. The change in tack from the ECB, while achieving its aim right out of the gate on Monday is likely to offer only a temporary reprieve. The move is an embarrassing endorsement for the work of the Eurozone's politicians whose efforts have gone unrecognized by the markets with peripheral bonds left floundering. Euribor futures moved to a fresh move for the year with the yield curve sharply lower than it was when the ECB started to tighten monetary policy in April.

British gilts - European stocks at one point in the morning staged a substantial rebound before investors woke up to just how deep the problems are especially without the antidote of growth. The selling resumed and by lunchtime in the U.S. shows little sign of recovery. Gilt yields in Britain were unchanged with dealers torn between the impact of the U.S. downgrade, which impacts global growth, and that of the ECB's sojourn into the secondary market for Spanish and Italian debt. The 10-year gilt stands at 2.69% while a gain for short sterling futures sent the implied yield lower by six basis points along the curve.

Australian bills - Bill futures traded in another sizeable range on Monday as investors responded to a fifth day of selling across stock markets around the Asia-Pacific region. Last week investors fast-concluded from the crumbs falling from the table at the central bank that it was more concerned about U.S. and European debt crisis that could yet end in a tailspin than it was about domestic inflation. Implied yields were already reflecting an about-face in the direction of short-term monetary policy before some profit-taking set in for Aussie bills. The 10-year government bond yield eased again to close at 4.52%, which compares to a short-rate set by the Bank at 4.75%. Weighing on sentiment on Monday was a decline in the number of jobs on offer in Australian according to an ANZ index of job advertisements for July. Its index declined by 0.7% having risen by 3.8% in June.

Japanese bonds - Government bond yields edged one basis point ahead to 1.003% on Monday as a strengthening of the yen induced further promises of intervention from Finance Minster Noda.

Canadian bills -Canadian bill futures have surged by a full one-quarter of a percentage point with dealers flattening out the yield curve as the prospect of monetary tightening follows Elvis. Bills of acceptance futures expiring in December saw the implied yield slide by 24 pips to 0.91% further eroding the distance with three-month Eurodollars. The spread has narrowed by one-percent over the last three months and halved in the past couple of weeks. Government bonds marched in lockstep with treasury yields sliding by 10-pips to 2.53%.

Andrew Wilkinson

Senior Market Analyst       

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