Oil Prices Above $70, Causing Sell-off in Stocks, Bond Yields and US Dollar
The last trading of the second quarter lived up to its reputation for delivering sharp volatility to the financial markets. Today, US equities went from being up over 50 points to down over 100 points before ending the day only slightly lower. Oil prices broke above $70 barrel while bond yields dropped by the largest amount since mid March. These factors along with weaker US personal income and personal spending data sent the dollar tumbling against the Euro, British Pound and Japanese Yen. Trading can be particularly active on the last trading day of a quarter, but add on a foiled car bombing attack in London and it is not surprising to see profit taking and liquidation. However the strength of the rebound in the stock market and the resilience of carry trades in general suggest that the market’s appetite for risk may not have reached its peak. Of course, this will be dependent upon how many more bombs are found in London and whether the situation escalates. If it does not, then the focus of the market will shift back to inflationary pressures. With oil prices at a 10 month high, it will not be long before the national average of gasoline prices moves back above $3 a gallon. The combination of rising corn, dairy and gasoline prices will certainly keep the Federal Reserve and probably many other central banks around the world hawkish. This means interest rates in these countries will either remain high or be increased over the next 6 months. Even though personal income and spending both fell short of expectations in the month of May, the gap between the two improved significantly and both the Chicago PMI and construction spending reports were stronger. Next week we have non-farm payrolls. Traders can look at the employment components of the manufacturing and service sector indices as well as the ADP survey to gage how non-farm payrolls may fare. Right now the market is looking for softer but healthy job growth. Throughout next week we will be covering this in detail on DailyFX.com.

Breakout Alert in the Euro / US Dollar (EUR/USD)
After fluctuating within a painstakingly narrow range over the past four trading days, the EUR/USD has finally broken out to the upside. Since this morning’s economic releases were mostly weaker than expected, the move was primarily driven by EUR/JPY buying as well as quarter end flows, German retail sales dropped significantly in the month of May while the annualized pace of French GDP growth fell short of expectations. Even though the Eurozone business climate indicator improved, consumer confidence deteriorated in the month of June. Although these are certainly disappointments, they will not deter the European Central Bank from remaining hawkish next week. They will continue to signal that interest rates are headed higher and ECB President Trichet may even say that the central bank needs to be “strongly vigilant,” which are code words for expect a rate hike at the next monetary policy meeting. Aside from the ECB interest rate decision, there will are also a number of very important Eurozone economic data due for release. This includes manufacturing and service sector PMI as well as PPI and German factory orders. The Swiss franc has rallied on the back of rising risk aversion. Next week, we are expecting Swiss PMI, CPI and unemployment. The recent weakness of the Swiss franc should continue to pave the way for stronger growth.

British Pound Unfazed By Terror Plots Ahead of BoE Rate Decision
The British pound is on its way to hitting a 25 year high despite the discovery of terrorist plots in London and the deterioration in consumer confidence. The resilience of the British pound is a clear sign that traders of the currency are focused on one thing and that is yield. The Bank of England will be announcing its interest rates decision next week and after the hawkish minutes from the last monetary policy meeting, the markets fully expect another 25bp rate hike. This would bring the yield up to 5.75 percent, widening the gap between US and UK interest rates in the process. When the central bank changes rates, a statement is released which means that not only will the actual interest rate change matter, but so will the tone of the BoE’s statement.

Softer Inflation Data Sends the Japanese Yen Tumbling
Earlier this week we compared the sell-off of carry trades to the movements in early June where a four day drop was merely a blip before fresh decade highs. The new highs reached by many of the Yen crosses today clearly indicates that the sell-off we saw earlier this week was carry trade profit taking and not liquidation. Softer Japanese data was the trigger for the latest wave of Yen weakness. Consumer prices dropped in Tokyo and nationally. With deflation still a bigger problem than inflation, the Bank of Japan will need push back any plans to raise interest rates. Overall household spending, manufacturing PMI and housing starts were all weak, leaving the jobless rate as the solitary piece of data to report an improvement. The quarterly Tankan release of business sentiment is due for release Sunday night. This tends to be both a very market moving number due to its infrequency of release. Economists are looking for an improvement. Be careful trading this piece of news because the first 10 minutes of the release can be extremely volatile.

New Zealand Dollar Hits Fresh 25-Year High, Australian Dollar Reaches 18 Year High
The strong rally in the Australian and New Zealand dollars indicate that the demand for high yielders continue to be voracious. Last night, New Zealand Q1 GDP printed right in line with expectations, but apparently the 1.0 percent growth was enough to bring kiwi bulls back into the market. Australian private sector credit was also strong in the month of May, which helped to exacerbate the rise in the Australian dollar going into next week’s interest rate decision. With retail sales, service sector PMI and the trade balance due for release, the Australian dollar will be in play next week. Meanwhile there is no New Zealand data on the calendar. As for Canada, the currency reversed strongly after hitting a 30 year high intraday. The line in the sand is drawn for USD/CAD ahead of next week’s IVEY PMI and employment data.

Kathy Lien is the Chief Currency Strategist at FXCM.