The European equity markets have reversed course as we head into lunchtime in Europe and are now lower on the day. After yesterday's rout, it looked like investors were staying on the side-lines and booking some profit before the weekend. However, the recovery was anaemic and seemed to be fuelled by the G-20 finance ministers' pledging to stabilise the economy in these turbulent time. Talk is cheap, so it seemed only a matter of time before markets sold off once more. It is no surprise that the trigger was headlines coming out of Europe. The G-20 may pledge to support economic stability but the policy makers who can provide that stability seem unwilling to give.

EU Justice Minister Viviane Reding backed the call for joint Eurobonds issued by the six members of the EU with a AAA credit rating - essentially a joint bond market for Europe's core. She also said this would not require an EU treaty change. However, a German finance ministry official came out and said that Germany remains firmly against the idea of Eurobonds, which are increasingly considered the only sustainable solution to the crisis. Added to this, an EU spokesman denied reports that banks that were found short of capital at the June stress tests would have the amount of time to raise capital slashed. The latest flare up in the sovereign debt crisis has engulfed the banking sector, and banks across Europe need to boost their capital buffers so they can deal with a sovereign default in future. The situation is now so severe that banks need to rely on national/ state injections of capital if cash from the private sector is not forthcoming. Headlines like this suggest that EU authorities don't understand the urgency with which Europe's banks need to boost their capital levels, which only adds to investor pessimism.

This has caused the euro rally' to turn around and it is now testing the lows of the day at 1.3440. Below here 1.3350 is a key Fibonacci support level that, if breached, could see a quick move lower to 1.3000. So we are nowhere near the end of this crisis, and testing weeks for risk assets - like we have seen this week - are unlikely to abate any time soon. There are some big event risks coming up for Europe (as if there wasn't enough already). Firstly, Spain's parliament dissolves next week in the lead up to the November 20 election. On 28th Sept Belgium (with its weak public finances) has a bond redemption to the tune of EUR12.6bn and on the 29th the German parliament is scheduled to vote on the expanded EFSF powers, which is likely to pass but could come with some strict conditions that may prevent further German support in future. The 30th sees the deadline for Spanish banks to have re-capitalised. So expect fireworks as we head into the fourth quarter.

Elsewhere, the dollar continues to dominate the FX world, as its strength is mirrored in euro weakness. The sell-off has been more severe in the growth currencies and EM such as the Aussie, Kiwi and Korean won. This suggests panic in the markets as all risk - even currencies of countries with strong fundamentals - get sold off. Interestingly, fixed income investors are diverging from their FX counterparts. Although the Aussie has collapsed to below parity with the dollar, the Aussie bond market has been attracting lots of interest, and bond yields are at their lowest level since March 2009. There could be two reasons for this: 1, the Aussie has stronger fiscal fundamentals than other western nations so is attracting safe haven flows, or 2, the expected rate cuts from RBA due to the weakness in the global economy. If China's slowdown persists then this will be bad news for Australia, so until the outlook becomes clearer the Aussie is likely to trade in line with general risk.

Ahead today, there isn't much economic data to fuel market moves. In this environment we expect investors to hold short-term positions. After all, we don't know what will be announced this weekend that could fuel risk-on/ risk-off next week. The IMF and World Bank meetings in New York will dominate things, with ECB President Trichet's speech later this evening is the highlight. Investors will be looking out for any dovish comment from Trichet after ECB council member Croene said the ECB may act to loosen monetary policy as soon as October if the crisis deepens.

Data Watch:
IMF & World Bank meetings (3 days)
17.15BST (1215ET) IMF's Lagarde Speaking - Readiness for the next financial crisis
18.30BST (1330 ET) US Dudley (FOMC Voter) speaking
19.00BST (1400 ET) CD Carney speaking
21.25BST (1625 ET) EU Trichet Speaking

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Kathleen Brooks| Research Director UK EMEA |

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