The announcement two days ago that the US is prepared to use nuclear weapons has a many-fold purpose. 1) It said to the Iraqi people that they should really think twice before supporting their ruler in a war against the US. There are a host of reasons to have the Iraqis believe that. 2) It told Saadam that attacking Israel will not work. Iraq no doubt thinks that if it is attacked by the US it will attack Israel to 1) kill Israelis and 2) to gain broad Arab support. It is an old ploy that all Arab leaders know. You can oppress your people to death as long as you are perceived as fighting the Israelis. (Hence, the perpetuation of anti-Isrel as a national priority in all Arab countries.) 3) It told Israel to stay out of the war in the only way they will listen, by assuring them that there will be nuclear retaliation for an attack on Israel's soil using WMDs.
What Saadam was no doubt thinking is that if something happens he will attak Israel and will be able to keep his regime. What the US said is that if he attacks Israel, the US will attack Iraq with nuclear weapons. Remember Saadam cannot fire WMDs in his own country against US troops without shooting himself in the foot (by destroying his own army) at the same time. He does not have the capability to attack the US. We are too far away. He would not attack neighboring Arab countries for fear of loosing more Arab support among now friendly Arab countries.
So the only country left for him to attack is Israel. So that is what the US was refering to. The US wants Israel to stay out of the war, for the same reason Saadam wants them in it. Both the US State Dept and Israel have announced publically and repeatedly that Israel will likely use nuclear weapons if attacked with WMD.
So what the US is saying is that now Israel knows to stay out of the war because the US will do Israel's job for her. The US will nuke Iraq just to prevent Israel from doing it. The hope is that this treat will stop Saadam from starting in the first place.
This is however a dangerous bluff. I assume that if the US is not prepared to follow through, Israel is. So I hope this ploy works.