The Australian dollar has dropped to a six-month low, extending last week's slide after US Federal Reserve officials called for a faster pace of rate hikes next year.
This came on top of news that China had seized a US underwater drone in the South China Sea, rattling investors and sparking a short selloff in riskier assets such as the Aussie dollar and US equities.
The currency fell as far as US72.66¢ in the early hours of Saturday, its lowest since early June, before steadying this morning to trade at US72.89¢, or where it began the year.
"Geopolitical headlines are likely to be the biggest driver of broader US dollar moves, while any escalation of the Sino-US conflict does not bode well for the Australian dollar," ANZ said in a note this morning.
The currency has dropped about 2.5 cents since the US central bank early on Thursday morning lifted rates for just the second time since the global financial crisis and signalled it's likely to tighten three more times next year, rather than the two times it had previously predicted.
The more hawkish tilt caught currency markets by surprise and sparked a surge in the greenback against most major currencies.
Outspoken Richmond Fed president Jeffrey Lacker, a noted hawk but not a voter this year or next, added to the US dollar rally by saying on Friday that three rate hikes next year might not be enough as inflation picks up.
"If we were to see a burst of demand growth, that would suggest a steeper path of rates to maintain price stability," he said.
"There is a range of paces of interest rate hikes that would qualify as gradual, including paces more rapid than one or two or three a year," he said. "My guess would be more than three."
Meanwhile, the more dovish Federal Reserve Bank of St Louis president James Bullard told the Wall Street Journal that more than one rate hike may be needed next year, a change of view for an official previously saying one increase was enough.
Traders will on Monday be watching for any signs that the federal government's mid-year budget update (MYEFO) could lead to a downgrade to Australia's coveted triple-A rating.
Ratings agency Standard & Poor's in June put the rating on review for a possible downgrade, should the government fail to outline a credible path to curb ballooning deficits and debt, and could react as early as this week.
A sovereign downgrade would flow more or less automatically into one-notch downgrades for the big banks and AAA state governments (NSW and Victoria), but financial markets were likely to react relaxed, said NAB global co-head of forex strategy Ray Attrill.
"To a large extent (for example, looking at where sovereign credit default swaps already trade) a downgrade is already quite well priced," he said.
"Doubtless though there would be some 'sticker shock' on the day – including a lower Australian dollar - were it to eventuate even if the willingness of foreign investors to continue owning Australian assets (government or otherwise) is unlikely to be materially impacted."