Dollar hurt by U.S. shutdown fears, Treasury yields at highest since 2014

By Dhara Ranasinghe

LONDON (Reuters) - The dollar wallowed near three-year lows on Friday as heightened fears of a U.S. government shutdown unnerved investors, while U.S. Treasury yields continued an upward march to hit their highest levels since September 2014.

Legislation to stave off an imminent federal government shutdown encountered obstacles in the Senate late on Thursday, despite the passage of a month-long funding bill by the House of Representatives hours earlier.

Without the injection of new money, no matter how temporary, scores of federal agencies will be forced to shut starting at midnight on Friday, when existing funds expire.

The dollar index, which measures the greenback's value against other major currencies, was down 0.3 percent at 90.230 and close to three-year lows hit this week.

It has already lost 2 percent in the early days of 2018.

"The fear of the U.S. government shutdown has made investors nervous," said Naeem Aslam, chief market analyst at Think Markets UK. "There is a strong possibility that the U.S. government shutdown may become a reality."

Market players said worries of a shutdown may have also weighed on sentiment in bond markets, which remain under pressure from expectations that strong economic data globally will encourage the U.S. Federal Reserve to press ahead with monetary tightening.

U.S. 10-year Treasury yields hit their highest level in more than three years at 2.642 percent on Friday, and were set for their biggest weekly rise in a month.

"It's a continuation of the trend and expectations for a normalisation of monetary policy," said Chris Scicluna, head of economic research at Daiwa Capital Markets, referring to rising U.S. bond yields.

FIRM GROUND

In Europe, equity markets opened firmer with the exception of London's blue-chip FTSE stock index. Germany's Dax index was 0.5 percent higher on the day and France's benchmark index was up 0.1 percent.

The MSCI world equity index, which tracks shares in 47 countries, touched fresh record highs bouyed by gains in Asia.

Optimism over the global economic growth outlook and improved corporate earnings have helped share markets rally at the start of 2018. Supporting economic confidence was data on Thursday that showed China's growth in 2017 accelerated for the first time in seven years.

China stocks ended at fresh two-year highs on Friday, with the Shanghai index posting its fifth straight week of gains. Japan's Nikkei closed up 0.2 percent.

EURO SHINES

The euro rose 0.4 percent to $1.2280 after hitting a three-year peak above $1.2300 earlier this week on expectations that the European Central Bank would take steps towards winding back on stimulus measures to normalise monetary policy.

The euro's rally was tempered later as some ECB officials voiced worries about the currency's strength.

China's yuan meanwhile breached the psychologically important 6.4 dollar level for the first time in more than two years the day after Beijing said annual growth was 6.8 percent in October-December, slightly above forecasts.

Oil prices meanwhile fell more than 1 percent as a bounce-back in U.S. production outweighed ongoing declines in crude inventories.

Brent crude futures were at $68.63 a barrel, down 1.03 percent on the day. On Monday, they hit their highest since December 2014 at $70.37.

U.S. West Texas Intermediate (WTI) crude futures were also 1 percent lower, trading at $63.28 a barrel.

Gold prices rose, supported by a weaker dollar amid worries about a possible U.S. government shutdown, but the metal was still on track for its first weekly drop in six weeks.

(Reporting by Dhara Ranasinghe; additional reporting by Shinichi Saoshiro Editing by Jeremy Gaunt.)