The U.S. dollar edged up to a two-week high against major currencies Friday as investors waited to see if U.S. politicians can strike a last-minute budget deal to avert tax hikes and spending cuts next year.
President Barack Obama and Democratic and Republican lawmakers were scheduled to meet on at 3 p.m. EST as the year-end deadline approaches. Members of both parties were divided on the odds of success.
"Headline risk is likely to remain a driver of FX markets in the near term," said Eric Theoret, FX strategist at Scotia Capital in Toronto.
Conflicting developments in Washington over the U.S. "fiscal cliff" have sparked volatility in the dollar. On Thursday, the dollar rose after Senate Majority Leader Harry Reid warned that the United States looks to be headed over the "fiscal cliff." But it gave up gains on news of a House of Representatives session on Sunday.
With time running short, lawmakers may opt to allow the higher taxes and across-the-board spending cuts to take effect and attempt to pass a retroactive fix soon after the new year. Standard & Poor's said an impasse on the cliff would not have an impact on the sovereign rating of the United States.
The dollar hit a two-week high against a basket of currencies at 79.930. It was last up 0.1 percent at 79.68.
The euro slipped 0.2 percent to $1.3214, having hit a session low of $1.3164 after triggering stop-loss sell orders around $1.3170.
The euro has made rapid strides since mid-November, gaining 5 percent in a month to hit an 8-1/2 month high of $1.3308 on Dec. 19 as worries about the euro zone debt crisis ebbed.
"Prices have become so overbought that there was little enthusiasm to rally further. Once the selling began, it quickly triggered stops across the board, taking euro/dollar below the $1.3200 level," said Boris Schlossberg, managing director of FX strategy at BK Asset Management in New York.
Although analysts partly attributed the euro's drop to year-end dollar demand and thin liquidity, they said unwinding of long euro positions also weighed on the currency.
"There is still a good chunk of skepticism among market participants about the euro being significantly higher than the $1.32-$1.33 level," said Ulrich Leuchtmann, head of FX research at Commerzbank.
"Speculative market participants are not very happy with these levels and look at it as a good opportunity to sell the euro, which is leading to the rapid drop in euro/dollar."
The euro fell 0.3 percent at 113.65 yen, having earlier hit a 17-month high.
The dollar slipped 0.1 percent against the yen to 86.01 yen, having earlier risen to 86.63 yen, its strongest since August 2010. Traders reported options barriers at 86.75 and 87.00 yen.
Expectations the new Japanese government will push for further easing in monetary policy have weighed heavily on the yen, and analysts say it could fall further. The yen has hit more than two-year lows against the dollar for three straight days.
The dollar has gained 12 percent against the yen in 2012, putting it on track for its biggest annual percentage drop since 2005.
The dollar looked set to end the week above its 200-week moving average, now around 84.95 yen, for the first time since late December 2007, a technical signal indicating further gains.
Jens Nordvig, global head of G10 strategy at Nomura Securities in New York, said he expects the Bank of Japan to move toward a 2 percent inflation target at the January meeting and plans for a foreign bond buying program to be announced in the second quarter.
"Mr. Abe has been consistent in signaling an aggressive push toward monetary easing. Importantly, this push is likely to be front loaded," he wrote to clients. Nomura forecasts the dollar will rise to 90 yen by the end of the second quarter, up from a previous target of 85 yen.