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Wednesday Look Ahead: Dollar Play at Center of Market Moves 

A down day for the dollar is basically now an up day for everything else.

That was Tuesday's trade, and it could be Wednesday's trade.

"It's the new normal," said Cowen head equities trader John O'Donoghue, half jokingly.

Stocks finished higher Tuesday after an early negative reaction to disappointing consumer confidence data, but the market's main move was more like a sideways drift. The Richmond Fed manufacturing surveyalso dropped into negative territory to its weakest reading since December, 2009.

The Dow was up 46 at 10,858, and the S&P 500 rose 5 to 1147. Bonds prices also rose, which sent the yields on the 3-year, 5-year, and 7-year to record lows. Gold also set a new record and was near $1311 in late trading. Some other commodities also finished higher, including silver, up 1 percent, and copper, up 1.1 percent.Oil finished slightly lower, down $0.34 per barrel at $76.18 per barrel.

The dollar though fell against the euro and yen. It was down 0.7 percent versus the euro, at $1.3578 and dollar/yen was at 83.96, close to a level where traders believe the Bank of Japan could intervene. The dollar rose, however, against sterling. Bank of England policy maker Adam Posen said the U.K. should move on its own quantitative easing.

"It's pretty much a dollar weakness kind of a day. What's interesting is it wasn't, I don't think, necessarily a risk on/risk off kind of a thing as much as it was general dollar weakness," said Robert Sinche, who joined RBS this week as head of global foreign exchange strategy.

"When you look at a day like today, it was a combination of this back and forth on the Fed and additional quantitative easing...and the data is on the soft side," he said. The Wall Street Journal Wednesday reported that the Fed is considering a more open ended, smaller program than its previous large scale QE program to buy Treasury securities.

"The QE mania still has a fire under it," said John Spinello, head of Treasury strategy at Jefferies. "The Fed doesn't know what they have to do and the market is leading on the side of them pricing in some action, whatever it is going to be."

Many economists expect the Fed to restart its QE program at its November meeting, and that expectation has been a negative for the dollar but has helped drive some commodities prices higher and put a floor under stocks. The theory is that QE would be a way to drive lending rates lower, at a time when the Fed's target Fed funds rate is already at zero. The Fed is also concerned about a lack of inflation and even a whiff of QE has already driven commodities prices higher.

"I think this whole issue of the Fed potentially exporting U.S. monetary policy does have a broadly positive impact on commodity prices," said Sinche.

Dollar Dilemma

At the same time, the upheaval in currency markets has set off reactions around the world. The Japanese and Swiss have confronted their rising currencies through intervention. The British have talked down sterling by talking up more quantitative easing of their own, and the Brazil's finance minister Guido Mantega this week said the world is involved in a "trade war and an exchange war."

The IMF's managing director Dominique Strauss-Kahn responded Tuesday by saying therisk of a currency war is low. But he did not rule it out and said the issue would be a topic at upcoming summits. The G-20 finance ministers and central bankers meet in Washington next week for IMF and World Bank meetings.

There was plenty of news circling the euro zone Tuesday that might have been negative for the euro on any other day. There was speculation of a Spanish ratings downgrade and more worry about Ireland's credit rating and bank problems. On Wednesday, general strikes take place in Italy, Portugal, Spain, and Latvia.

On Wednesday, European Central Bank officials attend the Eurofi Financial Forum in Brussels. German Bundesbank President Axel Weber is expected to speak.

There are also several Fed speakers Wednesday. Minneapolis Fed President Narayana Kocherlakota speaks at 10:15 a.m. in London on the FOMC. Philadelphia Fed President Charles Plosser speaks at 12:30 p.m. on the economic outlook, and Boston Fed President Eric Rosengren speaks at 1:15 p.m. in New York.

Traders are watching the Japanese quarterly Tankan business survey, which showed confidence at big manufacturers improving further in the third quarter. The U.S. does not get more data until Thursday, when weekly jobless claims and revisions to second quarter GDP are reported.

What Else to Watch

The Treasury auctions $29 billion in 7-year notes at 1 p.m. Wednesday, following the well-bid auction of $35 billion in 5-year notes Tuesday.

"On no news, the market will be well bid until Thursday," said Spinello, noting that the end of month is prompting some investors to buy duration because of index extensions.

O'Donoghue said as of now, there's no reason for stocks to stop their drift higher. He does not expect a double dip recession, and the market is already pricing in an election that changes the makeup of Congressm, with a Republican-run House.

"On a relative basis, to other instruments, they appear quite cheap, and there's no reason to buy them. There's no impetus right now to buy stocks, to have to own stocks, but relative to bonds, they're cheap," he said.

Companies to Watch

Family Dollar reports earnings Wednesday.

Investors will also be watching for reactions to news from Hewlett-Packard late Tuesday. HP shares rose after the company raised its earnings guidance.

Green Mountain Coffee shares were sharply lower after the company revealed the SEC is investigating its revenue recognition practices and relationship with a vendor, as it revealed a three-year old accounting error.

- Follow me on Twitter @pattidomm.

Questions? Comments? Email us at marketinsider@cnbc.com

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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