US Dollar
Thin market conditions have made trading extremely volatile in the currency market.  The US dollar ripped higher at the London open and continued to gain strength until the London close.  The first wave of dollar buying came immediately after the news of the foiled terror plot in London.  Over the past few months, the US dollar has been the primary beneficiary of rising risk aversion.  The second wave of significant dollar buying was at 10am EST, which led many people to believe that it was related to option expiration.  With not enough momentum to break above 1.29, which has held as resistance for the past four trading days, the combination of option expirations, mixed US economic data and speculation that the Fed could still raise interest rates if tomorrowâ�,��"�s retail sales report comes out strongly has helped the US dollar recuperate some its recent losses.  Although the trade deficit came in higher than analyst estimates, it narrowed from the previous month.  More specifically, the deficit shrank from -$65 billion to -$64.8 billion in June, driven by a rise in exports as well as consumer goods and automotive imports.  However, the change was so small that it should have a minimal impact on the revisions for second quarter GDP.  This increases the importance of next weekâ�,��"�s report on net foreign purchases of US securities.  The trade deficit has been a problem for over a decade but only becomes a bigger one when the US economy has difficulties attracting foreign investment.  Meanwhile as we said yesterday, traders are still holding out for tomorrowâ�,��"�s retail sales report.  According to the FXCM Speculative Sentiment index that we published this morning, Euro long positions are the lowest levels since December 2004.  This clearly indicates that traders are still hesitant to go short the dollar and suggests that a weak retail sales number could cause a far sharper movement in the EUR/USD than a strong one.  It would also confirm that the market is continuing to accentuate the negative and minimizing the positive.  Analysts are forecasting for consumer spending to rise by the strongest pace since the beginning of the year.   Although recent auto sales data does suggest increased spending, it is hard to believe that consumers would be as freewheeling with their cash at a time when oil prices are high, job growth is weak and mortgage payments are rising.  The risk for the number to swing either way is exactly the reason why some traders are still standing on the sidelines. 

Euro
For the past nine trading days, the EUR/USD has fluctuated within a narrow 190 pip trading range.  Although the Euro sold off in sympathy to the weakness in the British pound, the region is not without its own problems.  Wholesale prices in Germany fell 0.2 percent in the month of July after rising 0.5 percent the previous month.  The trade deficit in France also increased from -EUR1.7 billion to *EUR2.6 billion. Even though industrial production was slightly better than expected (it remained flat versus a forecast for a 0.2 percent decline), manufacturing production fell 0.5 percent in the month of June.  Softer inflationary numbers could be a bit concerning for the European Central Bank, but we will not see concrete evidence of this until tomorrow, when the consumer price numbers from Germany, France, Italy and Spain are due for release.  France will also be releasing the flash estimate of its second quarter GDP.  With growth already showing signs of slowing, the only reason the ECB has for continuing to raise interest rates is inflation.  Crude oil prices are down $2 today and if inflation also begins to slow, it would give the ECB a good reason to shift its stance.  So far, the annualized pace of growth in CPI for the Eurozone as a whole remains solidly above the central bankâ�,��"�s target, so for the time, whether the ECB moves ahead with their interest rate hike or not will depend upon oil. 

British Pound
The British pound came under pressure as soon as the news of the foiled terror plots in London hit the newswires.  Jittery citizens make for jittery markets.  The increased precautions and security at Londonâ�,��"�s airports along with concerns about flying will certainly have some impact on the UKâ�,��"�s transport and tourism sector.  Richard Lambert, a former monetary policy committee member and the current director-general for the CBI has said that there would clearly be an impact, but it â�,��"is far too early to know what the effect will be.â�,�  Business travel to London may also be affected by the increased terror alert level.  For an economy that is just beginning to improve, this latest shock is certainly not encouraging.  However we expect the UK government to bring things back to normal just as quickly as they did after the London bombings in 2005. Taking a look back at the charts of the British pound, it sold off for 3 more days after the bombing before bottoming out.  It then rebounded four hundred pips on the fourth and fifth day and eventually began a prolonged uptrend 14 days later. 

Japanese Yen
After a long stretch of weakness against many of the other majors, we are finally seeing strong signs of exhaustion in the Japanese Yen.  EUR/JPY, CHF/JPY, CAD/JPY and GBP/JPY all sold off significantly today as the sharp rise in the cost of consumer goods raises the likelihood of another interest rate hike by the Bank of Japan later this year.  Rising by 0.7 percent in the month of July, the increase in prices was driven by higher energy prices as well as stronger demand.  Consumer confidence also rebounded in the month of July, albeit slightly less than expected.  The Bank of Japan will be announcing their decision on interest rates tonight.  Even though they are expected to leave interest rates unchanged, hawkish comments are expected to come from central bank Governor Fukui.  Meanwhile both Australia and New Zealand reported a drop in their unemployment rates.  Though encouraging, it is not enough to warrant either central bank to reconsider raising interest rates in the near future.

Kathy Lien is the Chief Currency Strategist at FXCM.