Foreign exchange markets are extremely quiet today, which contrasts with the stock market. Equity indices in Europe have opened on a positive note. The Eurostoxx 50 index is higher by more than 1 per cent. Likewise, commodities are also joining the stock market party and Brent crude oil is up by nearly $3 per barrel since yesterday, although Brent dropped $0.50 this morning.

The spike in commodities and stocks is all down to expectations of QEIII in the US. So why the caution in forex markets? Although EURUSD has bounced off its 1.4380 lows from yesterday it remains below the 1.4530 high. Part of the reason is month-end flows that are supportive of the dollar. Stock markets had a torrid August and many fund managers were probably over-hedged, which tends to be dollar negative. Thus, at month-end money managers need to buy back dollars to balance their portfolios. This is likely to exert some temporary upward pressure on the buck. The second reason is that there is a lot of event risk coming up in the next couple of days. There is the ADP private sector jobs report today, ISM manufacturing tomorrow and then Non-Farm payrolls on Friday. So traders have a lot to chew on over the next few days. These data prints will be pivotal to determining whether there will be more QE from the Fed, so expect volatility, especially after Friday's payrolls report.

Although the economic data in the next few weeks will ultimately determine if there will be more QE, the bar to more policy stimulus is certainly falling. Fed minutes released yesterday showed that some members wanted additional policy accommodation to try and bring down the unemployment rate beyond keeping rates at an extremely low level until at least mid-2013. The minutes did not elaborate on what other measures could be used, but one has to assume further asset purchases or QEIII is on the table. Noted dove Evans explicitly called for more QE in a TV interview yesterday. Even Narayana Kocherlakota, who dissented at the August meeting, said he now agreed with leaving rates low for a pro-longed period in a speech yesterday, however, he continued to voice fears about the inflationary impact of more QE.

This is likely to determine the direction of the dollar in the next few weeks. When the markets got into a frenzy about QE2 a year ago the dollar fell more than 8 per cent in September. Although we believe that more QE is bad news for the greenback, the reaction may be more muted this time because the dollar is at such a low level on a broad-based basis already. We expect a slow grind lower in the buck, rather than a rapid capitulation.

Although the markets' focus is on the Fed, the Eurozone continues to muddle through the sovereign debt crisis. Today the German cabinet approved changes to the EFSF rescue fund agreed at the emergency July summit. This is the easier of the two hurdles to pass in Germany; the next is a Parliamentary vote that is due at the end of September. The IMF's fifth review of whether or not Greece is sticking to its austerity programme has been delayed. Last week the IMF said it would decide on whether to release Greece's next loan tranche at the end of September, so expect another rocky month with fears about a Greek default potentially denting the QEIII euphoria towards risky assets.

Added to this, Italy's Lower Chamber starts debating a watered down fiscal package tomorrow. This was one of the conditions in return for the ECB to step in and purchase Italian bonds and stabilise yields earlier this month. If the austerity package causes a political wrangle this may also dent investor sentiment.

Elsewhere, the SNB has tended to announce new measures to combat Swissie strength on Wednesdays; however the only statement on the SNB's website today was to announce that its FX reserves fell in July. The SNB may be happy with the depreciation of the franc in recent weeks, however, the Swissie is higher today as general dollar weakness grips the market. Added to the Swissie strength were technical signs that the currency was oversold and thus due a pullback. However, the future of the Swissie still rests in the SNB's hands.

Data Watch:
United States 12:00BST/ 0700 ET Challenger Job Cuts (Aug) YoY 59.4% last
United States 13:15BST/ 0815 ET ADP Employment Change (Aug) 100k exp, 114k last
Canada 13:30BST/ 0830 ET GDP (Jun) m-o-m 0.1% exp, -0.3% last
United States 14:45BST/ 0945 ET Chicago Purchasing Manager (Aug) index 53.3 exp, 58.8 last
United States 15:00BST/ 1000 ET Factory Orders (Jul) m-o-m 2% exp, -0.8% last
United States 17:30BST/ 1230 ET Fed's Lockhart Speaks

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Kathleen Brooks| Research Director UK EMEA |

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