FOREX-Dollar climbs as U.S. 10-yr yields hold near 2-year high
* Dollar supported by rise in U.S. yields
* Expectations of Fed tapering lead to dollar bids
* ECB's monetary policy seen remaining accommodative
LONDON, Aug 16 (Reuters) - The dollar edged up against a basket of currencies on Friday, drawing support from a rise in U.S. Treasury yields on expectations that the Federal Reserve may start withdrawing stimulus next month. Ten-year Treasury yields traded near two year peaks, while the gap between two-year Treasury yields and their Japanese counterpart rose to its highest in six weeks, Reuters data showed. The dollar index rose 0.1 percent to 81.25, helped mainly by gains against the euro. The euro was slightly lower on the day at $1.3340, while against the yen, the dollar was flat on the day at 97.40. Part of the reason for yen bids was because of a drop in global stock markets which underpinned demand for the safe-haven currency, traders said. Still, with the Fed set to become the first major central bank to start withdrawing stimulus, the dollar is likely to trade with a firm bias, analysts said. "Given that the 10-year U.S. yields are headed towards 3 percent we think the general direction is for a stronger dollar," said Tom Levinson, FX strategist at ING. "The dollar index has underperformed the rise in yields so there is a fair bit of catch-up to do." The yield on the benchmark 10-year Treasury note edged up to 2.78 percent in the European session from its U.S. close of 2.76 percent on Thursday, when it hit a two-year high of 2.823 percent.
U.S. DATA Later in the session, U.S housing starts for July and the University of Michigan confidence index could set the tone for bonds and to a large extent the dollar, traders said. "With US bond yields rising, we think the chance of dollar/yen breaking higher has increased," Morgan Stanley analysts said in a note. They added that with Japanese investors showing an increasing preference for foreign assets, the yen is likely to come under pressure, especially against the dollar. Recent data has shown Japanese investors turned to net buying of foreign debt, much of which was likely to have been Treasuries. The Bank of Japan embarked on a massive quantitative easing programme in April and with more fiscal and structural reforms likely to be put in place in coming months, more Japanese investors are looking overseas for higher yields. And even though the euro zone has emerged from a recession, the European Central Bank looks unlikely to change its accommodative policy stance any time soon. In the United States, though, good domestic data has bolstered expectations that monetary policy may not remain ultra-loose for long. "We remain constructive of the dollar and expect Fed to start tapering in the near term," said Kenneth Dickson, investment director at Standard Life Investments, which has $271 billion of assets under management.