SYDNEY (Dow Jones)--The Australian dollar surged in Asia trade Wednesday, lifted by a rallying U.S. stock market and follow-through gains for Asian equities. With risk tolerance and stocks improving throughout the globe, Australian bond prices slid on both ends of the curve. Laying the groundwork for a second-straight day of gains to start the holiday-shortened Australian trading week was a more than 2% increase for the Standard & Poor's 500 in New York trading. In turn, that move led to gains in Japan, Australia, South Korea and several other Asian stock markets. Gains for stocks, the euro and the Australian dollar were particularly notable in that traders shook off a plunge in German investor sentiment, as measured by the ZEW index. Nearly all markets have felt significant pressure on any euro-zone related weakness in the past few months, with market participants continuing to hold that region paramount to all others. "The optimism out of Europe has been difficult to understand this week given the market is now looking at some bad news and dismissing it," said BNP Paribas Foreign Exchange Analyst Rob Ryan. At 0615 GMT, the Australian dollar was quoted at US$0.8635, up from US$0.8547 late Tuesday. Against the Japanese yen, the Australian dollar was at Y79.01 from Y78.01. Ryan said he expects a pullback in both the euro and Australian dollar in the next couple sessions as some of that recent buying appears overdone, with selling likely around US$0.8660, or if that breaks, US$0.8725. Still, he remains bullish on the Australian dollar, noting "it will benefit as China is not tightening, the U.S. is not tightening and Europe is not tightening. As long as that liquidity flows through, the Aussie will benefit whenever risk isn't under pressure." Jonathan Cavenagh, a currency strategist with Westpac, is less convinced. "This rally isn't sustainable and I think we're heading back to the low-to-mid 80s at some stage," said Cavenagh. While the Australian dollar rallied, bond prices dropped, with the September three-year contract down seven ticks to 95.08 while the 10-year bond fell 7.5 ticks to 94.55. Matthew Johnson, an interest rate strategist with UBS, said Wednesday's decline, along with several other recent drops, represent a return to fundamentals in the bond market, though he advises to remain careful. "It's finally turned around as I think the market is pretty rich by any reasonable measure. But there's still a lot of uncertainty about whether the European issues have been contained," said Johnson, who added his strongest conviction is to play a flattening Australian yield curve. --By Geoffrey Rogow, Dow Jones Newswires; +61-2-8272-4686; geoffrey.rogow@dowjones.com

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