Dollar Soars On Flight to Safety
News that British authorities arrested a number of people in connection to a terrorist plot to smuggle explosives on board several airplanes which they planned to blow up mid-flight, caused national threat levels to spike in both the US and UK. The greenback experienced a marked flight to safety demonstrating once again that politics trump economics in the currency markets.  EUR/USD made a freefall drop of 60 points immediately on the threat news, and plunged an extra 100 points during the rest of the day. Traders appeared to ignore the FOMC's policy statement which deviated substantially from prior communiqu�ƒ©s by noting that "growth has moderated from its quite strong pace".  However, Richmond Fed's Lacker served as the sole dissenter of the group by voting for another 25 basis point hike, and giving hawks a glimmer of hope that the tightening cycle may not be over just yet.  To second that thought, Advanced Retail Sales closed out the week at 1.4%, higher than the anticipated 0.9% and much stronger than last monthâ�,��"�s downwardly revised -0.4%.  The remarkable improvement pushed the EUR/USD further down, and could lend support to a dollar bias in the week going forward if the market continues to believe that that rate hikes arenâ�,��"�t off the table completely.

With the Fed decision now behind us, event risk has declined greatly.  This week, however, could still prove to be dollar-critical as July CPI is expected to rise 0.4% from 0.2% in June, indicating that the FOMC may have faltered in their decision to hold rates at 5.25%. Additionally, the increasingly-watched TICS data is anticipated to post weaker at $63.2B, which still won't be enough to cover the ever-expanding trade deficit of $64.8B.  Empire manufacturing will start out the week for sentiment data, and may to slip to 15.1, while the U of M survey should follow suit by dipping to a reading of 84.  Sky high energy prices have hurt businesses and consumers alike, but the Philly Fed may indicate otherwise, as the reading could bounce back  to a reading of 8.   

Euro Pummeled on ECB Report
Euro-zone economic data for the week was extremely light, but the European Central Bank's Monthly Report was more than enough to set off a euro fallout, which was only exacerbated by the circumvention of a terrorist plot in the UK, as the EUR/USD broke below 1.2750 by the end of the week.  While the ECB's report indicated that the central bank consider current interest low and also believes that inflation is likely to stay above their 2% target, the European monetary authorities noted that major long term risks to economic growth have increased due to higher oil prices and geopolitical instability. The conclusion of the report lead traders to question the ability of the ECB to continue with policy tightening in the near term.  German CPI data didnâ�,��"�t help euro bulls either, as the inflation figure came out as expected at 0.4% in July, but the annual rate held below the ECB target at 1.9%.

This week's economic calendar remains quiet once again, but Euro-zone Q2 GDP figures are set to rise 0.7% from Q1.  The acceleration, however, may only be a temporary result of the World Cup boost seen in other parts of the Euro-zone such as France.  Industrial production is anticipated to slip 0.1% in June after jumping 1.6% in May, implying that the economic growth noted by the ECB may not be as broad based as previously thought.  A flat reading in Euro-zone CPI could be the news euro bears are looking for, as any signs of stagflation may indicate that the ECB jumped the gun by hiking rates on August 3rd.  Overall, diminishing European fundamentals may benefit euro shorts unless the eco data surprises to the upside.   

Yen Hurt By Weak GDP
The yen dropped to a two week low against the greenback after GDP data printed materially weaker than expected. Q2 GDP came in at 0.2% growth rate rather than 0.8% expected, but as we wrote on Friday, â�,��"Looking beyond the headline number â�,�¦ the economic news out of Japan was not nearly as bleak as the report would suggest. The two primary factors for the downward surprise were the reduction in government spending and a drawdown in inventories - both positive signs of improving demand from the private sector. Indeed private consumption rose a healthy 0.5%, while domestic demand deflator (in contrast to the overall GDP deflator which continued to contract â�,�“0.8%)  actually rose 0.1% indicating that at least in the private sector the decade long battle with deflation is definitively over. Currency traders sold the yen on the GDP news fearing that the BOJ will now stand down for the rest of the year after ending ZIRP by raising rates to 25bp in July. However, such speculation may be quite premature. If oil prices stabilize or recede from present levels, providing a spending boost to the Japanese consumer, the internals of todayâ�,��"�s report suggest that Japanese GDP could easily resume its prior pace of growth spurring the BOJ to act sooner rather than later as real interest rates in Japan continue to be negative. In the post announcement conference Governor Fukui was purposefully non-committal leaving open the possibility of further rate hikes should future economic data warrant such a move.â�,�

Next week the Japanese economic calendar is considerably more muted with Tertiary Industry Index the only report of note. Given the relatively strong undercurrent in this weekâ�,��"�s GDP numbers, the Japanese service sector could surprise to the upside and print better than the 0.2% expected which could provide some boost to the yen. Overall however, given Japanese holidays and general summer doldrums trading in USD/JPY should be relatively quiet.

Pound Terror
Economics didnâ�,��"�t factor much into pound trading last week as the old adage the currencies are political as well as economic assets couldnâ�,��"�t have been more truer than on Thursday when British authorities announced that they thwarted a plot to blow up several UK airliners headed for US. The terrorist scheme involved the smuggling of liquid explosives on board in carry on luggage and then igniting them in a series of suicide attacks. The news initially sent sterling sharply lower across the board, but once market players were assured that  no harm had come, the unit recovered against the euro and the yen, although it managed to lose 200 points to the greenback.

Poundâ�,��"�s recent strength has been the result of sharp change in sentiment regarding the renewed possibility of additional rate hikes from the BOE. After last weekâ�,��"�s surprising increase, market players have  started to speculate that the central has embarked on a new tightening campaign that is unlikely to stop at 4.75% current rate. Next week CPI and PPI data will either confirm or refute this thesis by showing the true extent of inflation in the pipeline. In addition, UK jobless claims and Retail Sales will also provide key evidence of  strength in the UK economy.

We remain dubious as to the idea of further rate hike by the BOE this year believing that the action two weeks ago was a one off event. The UK economy remains relatively fragile and is unlikely to absorb further rate increases without suffering some slowdown. However, if the data next week proves better than expectations it will vindicate the pound bulls and may provide further fuel to the pound rally, as the idea of yet another rate increase from the BOE will be taken more seriously by more market participants.

Swiss Surrender
The Swissie continued to lose ground against both the dollar and the euro this week despite producing yet another positive economic result as the SECO consumer climate indicator reached a reading of 12 â�,�“ the highest such value in five years. The rhythm was familiar as the Swiss economy operated like a finely tuned watch, but the franc suffered due to interest rate differentials.  With SNB mum on the subject of rates, the market is projecting only a 25bp hike at Central Bankâ�,��"�s September meeting and given ECB decidedly hawkish slant has continued to buy the EUR/CHF pair which by the end of the week traded at four month highs near 1.5820.

Next week, Producer Import prices may help out franc bulls if they show a significant pick up due to higher energy costs. Furthermore, if Retail Sales also prove robust, they will become yet another testament to Swiss economic strength. The Swissie however will not see a strong bid until the SNB unequivocally signals more hawkish policy on rates or conversely the ECB moderates its own hawkish posture. With the unitâ�,��"�s traditional safe haven franchise now taken up by the greenback, the franc has few fans despite stellar fundamentals.   

Boris Schlossberg is a Senior Currency Strategist at FXCM.