Aussie at risk of 25% decline by 2016: Societe Generale

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A decline in commodity prices and narrowing yield spreads could see the Australian dollar lose up to a quarter of its current value by 2016, according to a foreign exchange strategist.

"If the U.S. tightens as expected and the Chinese economic correction continues to drag down commodity prices [the Australian dollar] will fall," Kit Juckes, global head of foreign exchange strategy at Societe Generale wrote in a note Tuesday.

A 25 percent decline in the Australian dollar would bring the currency to around $0.72.

Juckes cites copper as an example of a commodity that is vulnerable to a correction. Societe Generale forecasts that prices for the red metal are set to fall 14 percent to around $6,000 a metric ton by 2016.

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"That would take fair value for Australian dollar/U.S. dollar down by about 9 percent," he said. Australia is the sixth-largest copper producer globally, exporting around 2 million tons annually.

On top of this, he says the narrowing in the spread between 5-year U.S. government and Australian sovereign bond yields will also weigh on the currency.

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"The economics team forecasts [the] Fed Funds [rate] moving above the Reserve Bank of Australia's cash rate in 2017, and if the 5-year rate spread narrows to 50 basis points by the end of 2016, that would drag Australian dollar/U.S. dollar fair value around 17 percent lower from today's level," he said.

Currently, the spread between 5-year U.S. government and Australian sovereign bond yields is 206 basis points.

"With huge caveats attached, that makes a 25 percent fall in the Australian dollar/U.S. dollar rate by the end of 2016 plausible," Juckes said.

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Positive sentiment for the AUD?

The Australian dollar came under pressure on Tuesday after Reserve Bank of Australia (RBA) Governor Glenn Stevens tried to talk down the currency. He said the Aussie dollar's current level wasn't consistent with underlying economic conditions, adding that the currency would be materially lower in the future given the country's declining terms of trade.

The Aussie fell below $0.95 on Tuesday, and continued to decline on Wednesday, touching a fresh two-week low of $0.9456.

However, Juckes notes that the currency's fall may take time to commence given commodity prices have recovered losses since July and U.S. yields have edged lower - both of which are favorable for the Aussie. "I still want to sell Australian dollar/U.S. dollar much closer to parity, much closer to the end of the year," he said.

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Mitul Kotecha, head of global foreign-exchange strategy at Credit Agricole, also expects a decline in the currency over the medium-term for similar reasons. But he believes a 25 percent fall is an aggressive forecast.

"I would imagine a move down towards $0.85 by 2016, it's going to be a gradual depreciation," he said.

—By CNBC's Ansuya Harjani; Follow her on Twitter: @Ansuya_H