Dollar rises on Fed expectations, waning yuan scare

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The dollar advanced on Monday, rising against a basket of currencies for a third straight session, as traders focused on potential U.S. interest rate hikes and shook off worries about a China-led "currency war."

The dollar index hit a one-month low last week after the People's Bank of China unexpectedly devalued the yuan, dampening expectations that the U.S. Federal Reserve will raise interest rates in September.

But after the PBOC set the yuan slightly above its fixing rate on Friday and soothed fears that Beijing was intent on a bigger devaluation, markets have once again turned attention to divergences in monetary policy among the world's major economies.

"Since China circled the wagons around its currency and restored some stability to its own markets, the (foreign exchange) market has defaulted to the Fed story of tightening," said David Gilmore, partner at Foreign Exchange Analytics in Essex, Connecticut.

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Against the euro, the dollar traded at its strongest in five days, reaching $1.1063 per euro before easing to $1.1082, still up around 0.3 percent on the day. The euro is expected to remain weak as the European Central Bank presses on with a 1 trillion euro asset-purchase program.

The dollar index has been benefiting from expectations the Fed will soon start raising interest rates that are already richer than those in comparable economies, and was last up 0.30 percent.

The greenback was ahead 0.1 percent against the Japanese yen at 124.40 yen and up 0.35 percent against sterling at $1.5592.

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A New York Federal Reserve survey showed manufacturing activity in New York state plunged in August to its weakest level since 2009 due to steep drops in new orders and shipments, and the dollar's gains narrowed.

"That headline number got people's attention," Gilmore said. "It is another element to put on the side of the ledger for a December vs. September start of Fed tightening."

But a later report from the National Association of Home Builders boosted the dollar. That data showed U.S. homebuilder sentiment rose in August to its highest level since a matching reading almost a decade ago.

Investors were also awaiting Wednesday's releases of U.S. inflation data and minutes from the Fed's latest policy meeting for possible clues on when the Fed will end an era of near-zero interest rates and raise some short-term rates for the first time in nearly a decade.