* Trump proposal seen as a step forward for tax cut
* Markets not convinced Congress can agree to any tax plan
* Hopes of Fed Dec rate hike, Trump tax cut support dollar
TOKYO, Sept 28 (Reuters) - The dollar and U.S. bond yields rose on Thursday after President Donald Trump proposed the biggest U.S. tax overhaul in three decades and as strong U.S. economic data supported the case for a Federal Reserve rate hike later this year.
The dollar's strength pressured many emerging market currencies and bonds, helping drag down MSCI's broadest index of Asia-Pacific shares outside Japan 0.4 percent to one-month lows. South Korean 10-year yields hit a 2-year high.
In contrast, Japan's Nikkei rose 0.55 percent, taking cues from gains on Wall Street, where the Dow Jones Industrial Average rose 0.25 percent while the S&P 500 gained 0.41 percent.
Small-cap U.S. shares, seen as benefiting the most from the proposed tax cuts, soared, with the Russel 2000 small-cap index notching a record high, rising 1.9 percent for its biggest one-day gain in almost six months.
"The fact that Trump made the tax proposal was seen as a step forward," said Hirokazu Kabeya, chief global strategist at Daiwa Securities.
Trump offered to lower corporate income tax rates, cut taxes for small businesses and reduce the top income tax rate for individuals.
Also helping to boost the dollar, the plan included lower one-time low tax rates for companies to repatriate profits accumulated overseas, which analysts say would lead to a temporary phase of sizable dollar buying.
European stock futures suggested gains for those markets too, with FTSE futures up 0.18 percent and German DAX futures up 0.25 percent.
Trump's tax proposal faces an uphill battle in Congress, however, with his own party divided, and the plan already prompting criticism that it favours companies and the rich and could add trillions of dollars to the national debt.
"It is hard to expect this proposal to pass the Congress smoothly. We have to pay attention to how the Republicans will view this," said Takafumi Yamawaki, chief fixed income strategist at J.P. Morgan Securities.
"It is possible that the net fiscal spending will be smaller than what the stock markets expect," he added.
The euro hit a six-week low of $1.1717 on Wednesday as the dollar broadly gained, and last traded at $1.1722, having shed 1.9 percent so far this week.
The dollar shot up to a 2-1/2-month high of 113.26 yen the previous day before stepping back to 113.08 yen Thursday.
The Canadian dollar extended its losses, suffering its biggest drop in eight months on Wednesday, after Bank of Canada Governor Stephen Poloz dampened expectations for further interest rate hikes this year.
Canada's loonie > fell to C$1.2469 to the U.S. dollar, its lowest in a month.
The dollar strengthened against many emerging market currencies while gold hit a one-month low of $1,281.5 per ounce.
"I don't see any changes to growth stories in emerging economies so I would assume selling in them will prove temporary, unless yields in the developed world keep rising sharply," said a senior currency trader at a major Japanese bank.
U.S. bond yields jumped with the yield on two-year notes rising to a nine-year high of 1.49 percent in anticipation of a rate rise in December.
Comments from Fed Chair Janet Yellen that the Fed needs to continue with gradual rate hikes have cemented expectations for policy tightening by year-end.
New orders for key U.S.-made capital goods grew more than expected in August, helping to boost optimism in the U.S. economy's outlook.
Yields on longer-dated bonds soared as Trump's tax proposal stoked worries about fiscal deterioration. U.S. municipal bonds were also sold for the same reason.
The 10-year yield rose to 2.357 percent, its highest in more than two months, compared to this week's low of 2.214 percent while the 30-year bond yield climbed to 2.901 percent after having risen 9 basis points on Wednesday - the biggest one-day rise in almost seven months.
Japanese yields rose in tandem with benchmark 10-year futures set for their biggest fall in three months, partly driven by expectation of fiscal easing after Prime Minister Shinzo Abe called a snap election expected on Oct.22.
Oil prices hovered a tad below the peaks hit earlier this week as the market consolidated after a strong rally this month.
Brent futures traded at $57.78 a barrel, down from Tuesday's 26-month peak of $59.49.
U.S. West Texas Intermediate crude (WTI) fetched $52.05 per barrel, below Tuesday's five-month high of $52.43 after oil stockpiles in the world's top consumer unexpectedly drew down, with refiners coming back online following Hurricane Harvey last month.
(Reporting by Hideyuki Sano; Editing by Shri Navaratnam and Eric Meijer)