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The markets are, so far, trying to end the week on a high. There is definitely a Friday feeling to the markets, with one eye on prices and the G-20 and the other on weekend plans. However, risk is still higher today led by forex as has been the case during the last few sessions.

Dollar weakness is pervading other markets pushing up stocks and commodities. EURUSD is hovering around the 1.3800 mark while AUDUSD has retraced 50% of its down-move from the July high to the early Oct low, when the cross fell below 0.9500. It's been a stunning rally from the Aussie and although it is being driven by overall market sentiment strong employment data and an RBA that doesn't look like it is about to cut rates could fuel Aussie strength once volatility calms down. The Chinese GDP data next week will also be pivotal for the Aussie in the near-term.

We could be on the cusp of a major move for equities since they have been range-bound for weeks, which is unusual for the major indices. Stocks are once again testing the air above some key technical levels. Although European indices have broken above here today, we need to see these gains sustained through the New York session so that we get a weekly close above 5,450 in the FTSE 100 before we can expect further gains. Volumes have been low this week, which suggests that markets still lack conviction, however, price action in the last couple of weeks suggest that if the conditions are right then markets will rally into the final months of the year.

The perennial problem is Europe. This weekend's G20 fin min meeting should pave the way to an agreement at the G20 leaders meeting in Cannes next month. Europe's leaders will need to deliver a big bazooka solution to the sovereign debt crisis to fill the market with confidence and make the whole nasty business go away. Right now the jury is out on whether this will happen. On the one hand, in the last three months the only concrete action has been the passing of the EFSF by all member states, which finally happened yesterday. This will now boost the fund to EUR440bn, which is deemed woefully inadequate to deal with the crisis. However, in recent weeks the European leaders have been talking the right game. Since markets work on a much faster time line than European politicians the equity and forex markets are willing to rally on the back of fighting talk with the hope that concrete action will be taken in the coming weeks.

There are two outcomes: either bulls are proved right and those that bought the bottom of the market picked up some great bargains, or we are in for a major disappointment. Time will tell. But today the markets seem to be happy with news that cash-rich emerging market countries are in talks with the IMF to create a special Eurozone rescue fund. Leaders from Brazil and China have said that they are willing to help solve the crisis since the problem is now too big for Europe to solve on its own. This has helped spur equities higher.

The logistics are yet to be decided, but it could involve the creation of a Special Purpose Vehicle or special bonds for Europe. This type of fund would have to be hundreds of billions of dollars in size, and if executed properly could help restore confidence to the markets and the global economy.

There are a couple of problems with this. Firstly, if the IMF - backed by BRIC nations - comes to the rescue of Europe then this will no doubt entail a political cost. They will want some say in the future economic direction of Europe, which may lead to a dilution of power in Brussels. It is hard to see the currency bloc's leaders agreeing to this in a hurry. The second point is less of an immediate concern, but it should still be considered. If emerging markets would rather buy from the IMF than directly purchase Eurozone debt or re-capitalise its banking system then the IMF would open itself up to the risk of loss since it would be on the line if this plan didn't work. As ever in Europe there never seems to be a golden bullet to stem the crisis...

This is being reflected in bond markets and credit investors are proving harder to please. The spread between French and German government debt widened dramatically to a euro-era high today. This was fuelled by fears that banking sector recapitalisation plans would hurt sovereign balance sheets, which is negative for France since it can't afford to inject cash into its banking sector. Belgian yields are higher today along with Spanish and Italian debt. The ECB was rumoured to be buying Spanish and Italian bonds and Italian yields have fallen as we lead up to the confidence vote in the Berlusconi government that is currently taking place in Rome.

Aside from Europe there was some good news from the corporate sector yesterday. Google reported strong earnings in the third quarter and JP Morgan didn't do as badly as expected. Although banks' earnings still look shaky, if economic data (especially in the US) starts to pick up then profits may well be protected as we head into the end of the year. This is important for stocks prices to appreciate into year-end; the other ingredient is a bank re-capitalisation plan. Although I believe that re-capitalisation isn't the be-all-and-end-all for banks, a Tarp-like structure would help banks if haircuts on Greek debt are to be implemented. My concern is that we get haircut contagion, with debt in Spain and Italy coming under the microscope - this would require a much larger re-cap plan than the one currently being bandied about at approx. EUR200bn.

It's another weekend with a lot to chew over. Positive noises from the G20 in Paris are likely to help risk sustain this rally as we move into next week.

Data Watch:
G20 Ministerial Meeting to 15/10/11
EU OECD survey of Ireland
EU Berlusconi Confidence vote
MX Mexican interest rate decision Last 4.5 Exp 4.25
13.30BST (0830 ET) US Import Prices Last -0.4% EXP MOM
13.30BST (0830 ET) US Retail Sales Last 0% LAST, 0.7% EXP
13.30BST (0830 ET) US Retail Sales Ex Autos 0.1% LAST, 0.3% EXP
13.30BST (0830 ET) US Core Retail Sales Last 0.1% LAST, 0.4% EXP
14.55BST (0955 ET) US Michigan Consumer Sentiment 59.4 LAST, 60.2 EXP

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

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