FX: QE Talk, Moody's Warning Hit Dollar

The dollar traded lower on Tuesday as the probability of the Fed announcing more QE at its Thursday rate-meeting increased, with one estimate putting the chances at 65%. More QE would depress yields and reduce safe-haven demand from international investors.

The yen in particular strengthened as its closest competitor for international capital. A warning from Moody's that it might downgrade the U.S credit rating due to high debt/GDP ratio also weighed. Against the euro, the dollar fell, as the prospect of a favourable court ruling in Germany on the legitimacy of the country's involvement in the euro-zone bailout fund helped risk appetite; the judges decision to reject an attempt to delay the ruling was interpreted as a positive sign. Dutch Election concerns also eased as polls suggested that the anti-bailout right parties' share was not increasing and much Data came out mildly positive: the Trade Deficit (Jul) lower than June but not as low as expected, coming out at -42.0bn vs. -44.2bn expected; Small Business Optimism (Aug) rose above forecasts to 92.9 from 91.2 and Economic Optimism (Sep) rose to 51.8 from 45.6 previous.

EUR
The euro rose versus the dollar as a result of heightened expectations of more QE from the Fed, which has its rate meeting on Thursday. The euro was further supported on prospects increased for a favourable ruling in a German Constitutional court on the country's contributions to the ESM bailout fund; a similar ruling passed the EFSF -- the old European fund -- and therefore is expected German involvement in the ESM will not be ruled illegal. The euro may also have strengthened after concern that Dutch general elections, held Wednesday, could lead to an anti European government taking power but diminished as polls showed continued strength amongst moderate centre parties. Only minor data was released today including the German Wholesale Price Index, which rose to 1.1% m-o-m from 0.3% in August; French Nonfarm Payrolls (2Q) QoQ meanwhile fell 0.1% as forecast.

GBP
The pound rose strongly on Tuesday after better-than-expected trade data showed a fall in the deficit, fueling hope that the U.K. is on a strong recovery path. Figures showed the Visible Trade Balance in July fell from -10068m to -7149m. The recent run of strong data reduced expectations that the BoE would increase QE, further supporting the pound against other majors, which are mostly expected to weaken as more stimulus is introduced. On Tuesday the dollar suffered as the probability of the Fed using more stimulus rose from under 50% to 65%, based on last week's poor employment data. Recent measures by the ECB to cap peripheral borrowing costs also helped the pound as they were seen as bringing stability to the whole region. The pound is also garnering support from safe-haven demand, and appears to increasingly be inhabiting a win-win position as whichever way risk goes it stands to benefit.

JPY
The yen strengthened significantly versus the dollar on Tuesday as a result of a rise in expectations that the Fed might use Thursday's rate meeting as an opportunity to announce QE3. Friday's lower-than-expected payrolls figure increased the chances the Fed might push the button given its mandate to target full employment. Against the euro, the yen fell as risk appetite increased on hopes that a German Constitutional Court Ruling would legitimise its contribution to the ESM bailout fund. Sterling, meanwhile, strengthened on a brighter outlook stimulated by better-than-expected trade data, which showed the deficit narrow. On the data front the BSI Large All Industry Index (3Q) QoQ rose to 2.2 from -3.1; BSI Large Manufacturing rose to 2.5 from -5.7; Japan Money Stock M2+CD (Aug) yoy rose to 2.4% from 2.2% previously; Money Stock M3 (4Q) rose above expectations to 2.1% vs 1.9% expected and the same previous.