GLOBAL MARKETS-U.S. stocks stabilize after selloff, dollar climbs
* Wall Street steady but volatility expected
* Dollar continues gains against euro, yen
* Crude drops, gold bounces back
By Leah Schnurr
NEW YORK, June 21 (Reuters) - Wall Street stocks stabilized while world markets were mixed on Friday after two days of steep losses as the dollar headed for its biggest weekly gain in almost a year following the Federal Reserve's notice that it plans to withdraw stimulus that has fueled the rally in equities this year.
Tokyo was an exception, with the Japanese stock market up 1.7 percent, while emerging markets remained under stress and extended their losses.
Easing fears about an immediate banking crisis in China helped make for a calmer tone, but short-term funding rates there remain elevated, especially for smaller lenders.
U.S. Treasuries prices reversed early gains to trade slightly lower.
"While volatility is going to remain high, the (stock) market next week will move to a consolidation phase," said Peter Cardillo, chief market economist at Rockwell Global Capital in New York.
He pointed to the quarterly expiration and settlement of June equity options and futures contracts later on Friday as another volatility trigger for the session.
About $14 billion is expected to change hands in index rebalancing-related trading toward the session's close, according to Credit Suisse, which could further add to volatility.
The Dow Jones industrial average was up 40.80 points, or 0.28 percent, at 14,799.12. The Standard & Poor's 500 Index was up 2.07 points, or 0.13 percent, at 1,590.26. The Nasdaq Composite Index was down 12.82 points, or 0.38 percent, at 3,351.82.
MSCI's broad world stock index, which tracks shares in 45 countries, was off 0.3 percent after dropping 3.5 percent in Thursday's rout. In Europe, the broad FTSE Eurofirst 300 index gave up 0.7 percent.
Fed Chairman Ben Bernanke heralded the end of the era of easy money on Wednesday when he said that if the U.S. economy keeps improving as expected, the Fed's asset purchases would be scaled back later this year and end completely by mid-2014.
The Fed is currently buying $85 billion a month in bonds, part of its huge stimulus effort that has driven many investors to embrace riskier assets and has sent U.S. stocks up about 15 percent for the year. Traders are now facing the task of unwinding those trades, which is expected to continue to roil global markets across asset classes.
"We think the stock markets still have a little bit further to go. We're a little bit less optimistic than the Fed as we think fiscal tightening is still going to drag on the economy in the next few months," said Larry Kantor, head of research at Barclays.
Benchmark 10-year Treasury notes were down 5/32 in price to yield 2.439 percent.
But the dollar continued to climb as Bernanke's view that the U.S. economy is improving prompted traders to start pricing in a rise in interest rates in late 2014.
"We're very bullish right now on the U.S. dollar," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.
He said the dollar is likely to gain regardless of Fed actions on tapering. If the economy improves and the Fed cuts back on its stimulus, the dollar will benefit from expectations of higher interest rates. But if the Fed maintains stimulus because the economy is weak, the dollar will rise on safe-haven demand.
The dollar rose 0.5 percent against a basket of currencies , putting it on track for a weekly gain of 2 percent, the biggest since early July, 2012.
The euro fell 0.5 percent to $1.3158 and the dollar gained 0.5 percent against the yen to 97.69 yen.
However, there was little respite across the emerging markets, with MSCI's benchmark index adding a further 0.9 percent loss to the 4 percent shed in Thursday's violent selloff, its biggest daily fall since September 2011.
As the Fed's policy tapering gradually pushes U.S. Treasury yields higher, the attractiveness of the returns on offer in star developing countries like Turkey and South Africa has waned.
The emerging markets index has fallen more than 5 percent this week, making for a year-to-date loss of around 15 percent, and many in the market see further falls ahead.
Gold drew some demand from investors attracted by the week's big price falls, although worries about China's sluggish growth outlook weighed on sentiment.
Spot gold recovered from a three-year trough and was up 1.3 percent at $1,294.76 an ounce, while gold futures climbed 0.5 percent to $1,239.20 an ounce.
But oil gave up some ground gained earlier, with Brent crude losing $1.60 to $100.55, while U.S. oil dropped $1.32 to $93.82.