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Fundamental Forecast for Australian Dollar: Bearish

– RBA raises its benchmark for a sixth time to 4.50 percent though Governor Stevens turns neutral
– Quarterly Monetary Policy statement from RBA warns Greek crisis could “sharply” temper global growth
– AUDUSD reverses sharply with broad US dollar rally

How could this happen to the Australian dollar? The currency plunged against the US dollar this past week and tumbled against other peers that don’t even enjoy the fundamental promise that the greenback maintains. Such a move would be expected for the New Zealand dollar which doesn’t have an established economic recovery to absorb speculative fears or the Canadian dollar without a meaningful interest rate to offset looming risk with remarkable return.

However, the Aussie dollar has both the yield and economic dominion to weather such uncertainties – at least you would think so.

But, in fact, speculation may have run dry for a currency that was already at the top of the risk curve.

Impressive growth is an advantage that the markets have priced in long ago; and interest rate expectations have leveled off. This yield consideration is perhaps the more prominent issue. While the nation’s benchmark lending rate has climbed to 4.50 percent this past week, Governor Glenn Stevens has tempered expectations of further tightening by suggesting the rates have returned to “normal” levels. At this point, the Australian dollar has everything to lose.

Top concern going into next week is the health of the Australian economy and the robustness of yield to be made there. After this sixth rate hike from the RBA since the last financial crisis ended, the markets are pricing in a mere 32 basis points worth of total hikes over the coming 12 months. This contrasts with nearly 200 bps expected from the RBNZ, 169 bps for the BoC and even 56 bps to the Federal Reserve.

It is looking very likely that the rest of the world will start closing the gap with Australia when it comes to interest return; and that means a smaller yield differential to encourage investors to buy into an already expensive exchange rate.

The other issue is that policy officials are now voicing concern that the island economy is not as divorced from the world’s problems as many believe it to be. The Quarterly Monetary Policy Statement warned that fiscal problems in Europe could slow the world economy and lead to a sharp decline in commodity prices.

Perhaps underappreciated is the secondary impact that China could have. The fastest growing economy in the world and the destination for the bulk of Australia’s commodity exports, a general fading in risk appetite could exacerbate already existent asset bubbles and immediately pinch off an artery of growth for the continent. Relatively few are truly accounting for China’s wavering.

Big themes like a Greek-born financial crisis or Chinese slump are the most threatening due to the sheer magnitude of the fallout. At the same time, the timing on these concerns is still somewhat in the distance.

In the meantime, currency traders will concern themselves with indicators that will assess whether the Australian economy is staring to plateau. For precedence, the employment change figures for April carry the most consistent history of market impact. A 22,500 net increase in jobs would extend a notable trend; but then again, caution will make the masses far more sensitive to disappointment than improvement.

More difficult to interpret but perhaps an even greater threat to speculative health is the 2010-2011 federal budget report. Should the government attempt to remove stimulus too quickly, it could be considered a blow to the engine of growth. – JK

For weekly forecasts for the US and Aussie Dollar, visit DailyFX.com.

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