Talk of Slowdown Scares Dollar Longs
The conflict between Israel and Hezbollah continued unabated this week as casualties mounted and oil hovered near the $75/bbl level, but the boost to dollar longs from flight to safety concerns disappeared after Chairman Bernankeâ�,��"�s testimony on Wednesday in front of Congress. Instead of hammering away at the inflation theme, the Fed chief once again surprised the markets but issuing a decidedly neutral statement that focused more on the dangers of a possible US economic slowdown rather than the need to contain inflationary pressures. His words were all the more unexpected coming right after red â�,��"hotâ�,� PPI and CPI gauges which rose 0.5% and 0.3%  versus 0.3% and 0.2% respectively. Other economic data was also supportive to the greenback with Industrial Production climbing 0.8% from 0.5% projected and TICS far exceeding the $58.4 Billion estimate to print at $69.6. None of the positive economic news was of much help to dollar bulls however. The end result of Dr. Bernankeâ�,��"�s  policy U-turn was a massive markdown in the August Fed funds futures rates from near 90% certainty of a rate hike to even money along which led to a  245 point turnaround in the EUR/USD. For the week the greenback lost only 38 basis points to the euro, but the slight loss masked the true extent of the decline after a massive dollar rally in the front part of the week took the pair below the 1.2500 figure for the first time in weeks.

The slowdown story is very likely to dominate trade next week. Market participants have an array of data ahead of them including Consumer sentiment numbers from both the Confidence Board and U of M as well as housing data which may prove key to the direction of the pair. Housing has been the back bone of the Us economy for the past 3 years and if the market sees material slowdown in that sector the fears of a US economic slowdown and the concomitant pause in the Fed rate hike campaign will only increase putting further pressure on the greenback.

Inflation in the Euro Nations?
The euro continued its primary trade as the anti-dollar producing little market moving news last week. The most prominent release to affect currency trading in the pair the ZEW survey of European investment managers which declined for the sixth straight month reaching a near two year low on the back of concerns about high oil prices and higher exchange rates. The ZEW, however has been notoriously wrong declining most of the year while  the EUR/USD has strengthened. Indeed at least part of its fears were allayed with the report of better than expected Industrial Production data which jumped 1.6% versus 1.4% expected. Thus, the aftereffects of the ZEW survey were fleeting  and with little other EZ data for traders to consider the unit took on its familiar role as the anti-dollar and rallied strongly once market sentiment about additional US rate hikes began to change after Chairman Bernankeâ�,��"�s testimony on Wednesday.

Next week German CPI data and the IFO survey will be the marquee economic events to govern trading. The inflation data is expected to rise to 0.4% from 0.2% and if it does so it would nearly cement the expectations for a 25 basis point rate hike out of the ECB at the August 3rd meeting. The IFO on the other hand is expected to decline for the first time in months. However, if the drop in the reading is as mild as most market analysts forecast it is unlikely to impact euro to the downside.  The central battle next week in the EUR/USD trade will be fought around the validity of the escalating of a US economic slowdown versus mounting evidence of increased inflationary pressures in the Euro-zone. If both of those trends are confirmed by the economic data as the week goes by, the EUR/USD may see further gains.

Yen Yearns for Yield
Speculation on the carry trade was the name of the game last week when we said, â�,��"The yen fell to multi year lows against the British pound and near all time lows against euro earlier in the week, but tonight, yen appreciated materially with USD/JPY tumbling more than 100 points, breaking the 116.00 level for the first time in five days.â�,�  US Fed Chairman Bernanke was the catalyst in all of this, as his commentary focused more on economic slowdown rather than containing inflation, essentially inferring that further rate hikes may not be on the Fedâ�,��"�s agenda.  More interestingly, BOJ Deputy Governor Toshiro Muto made statements saying that Japanese rates are likely to remain low for an extended period of time.  So why the yen bullishness?  At this point, it is become more and more likely that the US will pause its tightening  monetary policy while Japan will continue to raise rates albeit slowly.

Economic data from the past week only reiterates the point, as the significant Tertiary Industry Index jumped 0.5%, beating expectations of a 0.3% decline.  Convenience store sales, an important indicator of consumer spending, was similarly optimistic, rising 0.6% against Mayâ�,��"�s reading of â�,�“2.9%.  The Leading Economic Index met the anticipated 77.3%, far better than Aprilâ�,��"�s figure of 54.5%, as the reading remains well into the expansionary zone.  All in all, the figures bode well for the Japanese economy and leave upside risk for monetary tightening by the BOJ.

Event risk in the next week centers heavily upon the Tokyo and National CPI numbers for June.  The annual Core Tokyo reading should initiate the most price action, as the figure is anticipated to rise 0.4% in July while the annual Core National CPI is likely to hold at a solid 0.6% in June.  Should the inflationary measure meet or rise above expectations, traders will be able to count on the BOJ to erase the term â�,��"deflationâ�,� from their vocabulary.  Given the solid global export demand seen as of late, the merchandise trade balance could balloon to �,¥833.2 billion in June from Mayâ�,��"�s lowly oil price-driven fall to �,¥382.8 billion. Trade growth in Japan remains firm and underpins strong domestic economic demand, which will only be reasserted by positive readings on retail trade and a steady jobless rate later in the week.  After being battered for a few days last week, Yen bulls should continue to reap rewards in the week going forward.

Inflationary Data Pleases Pound Longs
Traders flocked to the Pound this week as the currency surged almost 400 points by Friday. The combination of inflationary signals out of the consumer and housing arena along with strong retail sales figures completely negated the neutral commentary by the Bank of England in the minutes from their most recent MPC meeting.  As expected, members voted unanimously to maintain the 4.50% benchmark rate for the UK.  At the time of the meeting, CPI readings for the year were 2.2%.  This past week, however, saw the figure jump past the expected 2.3% to 2.5%.  Likewise, the RICS House Price balance skyrocketed to 28% in June, leaving traders to wonder how much longer the BoE will be able to hold their neutral stance.  Stellar retails sales of 0.9% and more importantly, stronger than anticipated Q2 GDP growth of 0.8% all added to speculation of a rate hike by the end of 2006.

Following the stream of economic data from last week, this week will be much quieter as calendar remains light.  Nevertheless, Pound bulls stand to benefit from a flurry of encouraging readings.  First up, CBI Distributive Trades for July are anticipated to improve to a reading of 10, in line with the impressive retail sales figures seen last week.  Next, Nationwide house prices are likely to accelerate once again in July by 0.5%, leaving traders to wonder, â�,��"What housing slowdown?â�,�  Finally, CBI Industrial Trends for July should remain supportive of the suddenly buoyant industrial sector, as the figure should rise to a reading of â�,�“10 from â�,�“12.  Market participants should look to Central Bank speak throughout the week for direction into how the MPC may perceive these growth figures.  The fundamentals, however, should be supportive of a continuation in the GBP/USD rally.

Standout Data Should Strengthen Swissie
It took dovish rhetoric by the US Fed to make it happen, but the Swiss franc finally started to make up its three weeks of losses against the greenback on Wednesday but the unit still ended the week weaker than all of the other majors.  Economic data out of Switzerland has shown skyrocketing growth and continues to improve, as acknowledged by the Swiss National Bank via two consecutive quarterly rate hikes in 2006.  The probability that the SNB will continue to raise their benchmark throughout the rest of the year increased this week when Producer and Import Prices unexpectedly accelerated at 3.1%, the fastest annual pace in over 16 years in June versus an anticipated reading of 2.9%.  Inflation served as a double edge sword, however.  While companies were given more scope to raise prices on their goods, importers did the same, leading to a narrowing of the Swiss trade surplus to â‚£0.94 billion.  Exports, remain strong though, with the June figure coming in at 13.2%--more than enough to underpin domestic growth going forward.  The only real downturn was in Adjusted Real Retail Sales, which fell from an all time high of 12.2% to -2.3% on record oil prices. However, the volatile sales figure is still considered to be trending higher and consumer spending remains healthy.

The economic calendar for the coming week should lend strength to the Swiss franc, as the two most important indicators for the country are likely to post strong gains.  On Tuesday, the UBS Consumption Indicator is anticipated to rise even further from 1.865, the highest reading since April 2002, as household spending has been encouraged by low unemployment numbers and mounting consumer sentiment.  Thursday's release of the even more significant KOF Leading Indicator should show similar improvements, as the reading could climb to 2.55 in July from 2.50 on stellar business confidence.  Given the solid expansionary signals to be seen out of Switzerland, both Swissie bulls and SNB hawks should be placated this week.

Boris Schlossberg is a Senior Currency Strategist at FXCM.