Dollar steadies ahead of Fed, yuan breaks key level

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By Rae Wee

SINGAPORE (Reuters) - The dollar hovered near its recent peaks on Friday as expectations that the Federal Reserve would need to hike more to tame inflation sent Treasury yields higher and kept the greenback in demand.

The towering dollar pushed the offshore yuan past the critical threshold of 7 per dollar for the first time in more than two years overnight, with the yuan hitting a trough of 7.035 in Asia trade.

The onshore unit similarly broke the key level soon after markets opened on Friday, and last traded 7.0095 per dollar.

Data on Friday showed China's economy was surprisingly resilient in August, with factory output and retail sales both growing more than expected last month. But a deepening property slump weighed on the outlook.

"Growth, policy divergence between the US and China could continue to support the USDCNH in the next few months, even if some pullback is seen intermittently," said analysts at Maybank, who noted some "upside surprises" in the Chinese data release.

Often used as a liquid proxy for the yuan, the Aussie hit a two-month low of $0.6685, before regaining 0.28% to $0.67195.

The kiwi likewise fell to $0.5956, its lowest level since May 2020, and was last up 0.23% to $0.5979.

The euro was up 0.05% to $0.99995, while sterling fell 0.03% to $1.1468.

Traders will now shift their focus to a slew of monetary policy meetings by the Federal Reserve, the Bank of Japan (BOJ), and the Bank of England next week, with the Fed in centre stage.

U.S. Treasury yields rose after data released overnight showed U.S. retail sales unexpectedly rebounded in August, while a separate report from the Labor Department showed initial claims for state unemployment benefits fell 5,000.

The two-year U.S. Treasury yield, a bellwether for interest rate expectations, scaled to a fresh peak of 3.901% on Friday, the highest since 2007. Fed funds futures point to a 75% chance of a 75 basis point rate hike at next week's meeting and a 25% chance of a 100 bps increase.

This could spell further pain for the battered Japanese yen, which has been a victim of the surging greenback and growing interest rate differentials.

But three sources familiar with the thinking of the BOJ said the central bank has no intention of raising interest rates or tweaking its dovish policy guidance to prop up the yen.

The dollar was 0.09% lower against the yen at 143.36, but remained on track for a fifth straight weekly gain.

"The dollar strength will persist, at least in the near term. The two key factors that are supporting the U.S. dollar are still in place, so we've got very hawkish market pricing for the FOMC ... and also, we've got this worsening global growth outlook," said Carol Kong, senior associate for international economics and currency strategy at Commonwealth Bank of Australia (OTC:CMWAY).

"As long as the prospect for the global economy is still weak, the U.S. dollar can remain strong and perhaps edge a little bit higher."

The U.S. dollar index firmed at 109.69, close to its two-decade peak of 110.79.