Dollar stands tall as traders brace for tapering

The dollar traded near its strongest levels of the year on Wednesday, after driving higher with U.S. yields and benefiting from investor nervousness about the Federal Reserve starting to withdraw policy support just as global growth headwinds gather.

The yen, which is sensitive to U.S. yields as higher rates can draw flows from Japan, touched an 18-month low of 111.685 per dollar early in the Asia session.

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The euro, which fell to a one-month low overnight, sat at $1.1687 and was close to testing major support around its 2021 low of $1.1664 and its Nov. 2020 low of $1.1602.

Elsewhere, the dollar was firm after broad gains overnight lifted the dollar index against other major currencies to an 11-month high of 93.805. It was last marginally below that level at 92.728.

U.S. Treasury yields have surged lately - with benchmark 10-year rates up 25 basis points in five sessions to 1.5548% - as Fed tapering looms before the year`s end and as inflation starts to look stickier than first thought.

"Compared to the unencumbered optimism at the start of the year, it is a twilight zone for markets as 2021 approaches its end," Deutsche bank strategists said in note that upgraded forecasts on the dollar and recommended a bet against the euro.

"Persistently stagflationary dynamics - lower growth but a hawkish Fed - leave little room for a dollar downtrend," they said.

Along with the Fed`s tone, energy prices are surging and concerns are gathering about the growth outlook in China - now at risk both from a messy collapse at developer China Evergrande and rolling power outages that are hitting output.

Sterling copped a particular beating overnight as concern over the economic impact of a shortage of gas and a scramble for fuel pulled it 1.2% lower on the stronger dollar, its largest daily fall in more than a year.

MSCI`s emerging markets currency index suffered its sharpest fall in three weeks overnight and extended its decline on Wednesday to a one-month low.

"In our view the dollar is unlikely to retreat significantly until confidence in emerging markets has been lifted," said Jane Foley, senior FX strategist at Rabobank in London.

"This will be more difficult to achieve in an environment in which is dominates by fears of both higher energy prices and firmer U.S. rates ... our 6 month euro/dollar target of 1.16 looks set to be hit sooner that we had been anticipating."

The Australian and New Zealand dollars were languishing and the kiwi slipped to a fresh one-month low of $0.6939. The Aussie dipped to $0.7227.

Central bank meetings loom next week in both countries and swaps pricing points to the Reserve Bank of New Zealand following Norges Bank and lifting rates.

"NZD/USD remains stuck around $0.7000, as the effect of the hawkish RBNZ is offset by increasing expectations of the Fed," said Westpac analyst Imre Speizer.

Ahead on Wednesday, Japan`s ruling party votes for a new leader who will almost certainly become the country`s next prime minister.

European Central Bank (ECB) President Christine Lagarde, Fed Chair Jerome Powell, Bank of England Governor Andrew Bailey and Bank of Japan Governor Haruhiko Kuroda are panelists at an ECB forum.