U.S. and European stocks rallied, Treasuries slipped and the dollar weakened on Tuesday on expectations a German court would not interfere with a euro zone rescue plan and that the Federal Reserve would again ease U.S. monetary conditions.
The prospect of Fed easing weighed on the U.S. dollar since it pointed to lower returns on dollar-denominated assets. In addition, the view that the German court would approve the ESM or euro zone bailout fund helped the euro reach a four-month high versus the dollar.
"The strong dollar has helped keep U.S. inflation very low, but the Fed wants the dollar to weaken when its strength starts to hurt the U.S. economy," said Robert Robis, head of fixed income macro strategies and senior portfolio manager at ING Investment Management in Atlanta, Georgia.
The euro hit $1.2863 on Tuesday, climbing past its 200-day moving average around $1.2834 and leaving it up 0.8 percent. The euro has rallied more than 6.0 percent from its two-year low of $1.2042 seen in late July.
The dollar also sold off after Moody's Investors Service said the United States could lose its triple-A debt rating if next year's budget talks do not result in a lower debt to GDP ratio.
Standard & Poor's rating agency cut its triple-A debt rating on U.S. debt on Aug. 5, 2011. Investor Warren Buffett reacted at the time, saying U.S. debt merited a "quadruple-A" rating.
STOCKS UP, TREASURIES DOWN
Meanwhile, U.S. and global stocks rallied and Treasury prices slipped.
"The scenario is looking very much like September 2010 when Fed Chairman Ben Bernanke signaled an easing at the Jackson Hole conference and the Fed eased in November," Robis said.
This time, the Fed is likely to ease sooner, analysts say, but the impact of the prospective easing looks similar.
"Equities rally, the Treasury curve steepens, and the dollar weakens," Robis said.
Investors expect the Fed to announce additional stimulus measures when the central bank announces its policy decision after a two-day meeting on Thursday.
The Dow Jones industrial average was up 83.56 points, or 0.63 percent, at 13,337.85. The Standard & Poor's 500 Index was up 6.35 points, or 0.44 percent, at 1,435.43. The Nasdaq Composite Index was up 5.92 points, or 0.19 percent, at 3,109.94.
The benchmark 10-year U.S. Treasury note was down 10/32 in price, its yield rising to 1.69 percent from 1.66 percent on Monday, as investors positioned for $66 billion in new U.S. government debt supply this week.
The MSCI global share index climbed 0.51 percent to 330.77.
Markets for riskier assets have been rallying ever since European Central Bank President Mario Draghi said in late July that the ECB would do whatever it would take to preserve the European currency union. Last Thursday, Draghi pledged unlimited bond buying to contain the borrowing costs of Spain and Italy.
"Draghi's speech in late July kick-started this," Robis said.
Another event investors are watching is a Dutch general election on Wednesday, with voters torn between bailouts for troubled euro zone economies and austerity measures locally.
European shares were up 0.3 percent at 1,107.17 but stocks on French and German exchanges rose 0.9 percent and 1.3 percent respectively.
Bund futures were up 9 basis points at 140.41 as uncertainty remained around the outcome of the ESM ruling and as worries resurfaced on Greece's fiscal repair plans.
Oil prices remained firm, with Brent crude futures at $114.75 a barrel. Safe-haven favorite gold, helped by weakness in the dollar, stood at $1,732.99 an ounce.
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