Greek two-year notes surged, driving yields lower for the first time in nine days, after Chancellor Angela Merkel retreated from German demands that bondholders be forced to bear a "substantial" share of a new rescue.

Ten-year Greek yields also slid. Merkel will work with the European Central Bank to resolve the crisis, she told reporters in Berlin today at a joint press conference with French President Nicolas Sarkozy. Irish two-year yields, which earlier climbed above 13 percent for the first time, fell, while German securities dropped as stocks rebounded.

"The market is taking it positively that there is a Franco-German agreement, even though there are still elements that need to be resolved," said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. "It's understandable that markets have reacted with some relief, but we're not going to price out risk on a wholesale basis. It puts some downside to core markets, such as bunds, and allows for some spread tightening from very wide levels."

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