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Central Bank Stance Pressures Australian Dollar

NEW YORK ( TheStreet) -- In early May I issued a sell recommendation for the Australian dollar while it was still trading at more than parity against its U.S. counterpart.

Values in the Aussie have since fallen 11% against the greenback and 12% against the yen. Year to date, the Australian dollar is the worst performing currency amongst those used in the developed markets.

The most recent plunge lower has been propelled by comments from Reserve Bank of Australia Governor Glenn Stevens, which suggest that the central bank will cut interest rates again before the end of the year and that declining currency values are appropriate given the state of the country's economy.

For those holding ETFs such as the CurrencyShares Australian Dollar Trust (FXA), this means the bad news has not yet come to its conclusion, and that further declines are still likely.

Stevens' comments come as a surprise to some, as consumer price inflation is holding at relatively elevated levels of 2.4%, and further rate cuts from the RBA could send price pressures above the central bank's target inflation rate.

But the weakening macroeconomic environment and most recent housing figures suggest that this is still the most likely outcome. Interest rates in Australia are already at historic lows of 2.75%, and additional rate cuts could bring real short-term rates to less than zero -- further reducing the incentive for investors to hold onto the Australian currency.

Specifically, building approvals for June dropped by a massive 6.9% (the most since July 2012), as markets were anticipating a rise of 2.0% for the month. Most troublesome here is the fact that the housing market has been one of the stronger segments of the economy, and the big miss here suggests a period of prolonged weakness. These data also show that the RBA's prior rate cuts have not generated their intended results.

If this wasn't enough, external risks are mounting as well. Expected growth rates in China (Australia's largest trading partner) have dropped to 7%, forcing the People's Bank of China to inject liquidity into money markets and enact programs to significantly reduce production capacity before the end of this year.

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