NEW YORK (MarketWatch) -- The U.S. dollar gained ground Friday, lifted by apparent short covering as traders booked profits ahead of next week's meeting of U.S. Federal Reserve policy makers.
The dollar index (DXY 76.55, +0.36, +0.47%) , a measure of the greenback against a trade-weighted basket of rivals, rose to 76.525, up from 76.190 at the end of New York trade on Thursday. The index set a new 12-month low earlier this week.
"The U.S. dollar rebounded against all the major currencies as a part of the profit-taking theme," said T.J. Marta, founder and chief strategists at Marta on the Markets.
A test of the 76.00 level for the dollar index was "a bridge too far" for dollar bears this week, said Paul Rodriguez, a technical analyst at Bank of Scotland.
The euro, which had pressed to new yearly highs against the dollar, was slightly lower. The single currency changed hands at $1.4697, down from $1.4737 Thursday.
The dollar traded at 91.43 Japanese yen, little changed from late Thursday.
U.S. stock indexes posted small gains early in the day, following the previous day's modest declines.
The temptation to book profits may be amplified by the lack of economic data due for release on Friday, analysts said. Traders that shorted the dollar -- placed bets that it would decline -- may unwind those positions to lock in gains.
The dollar index has lost 0.23% this week while the euro has gained 1.22% and the British pound is up 1.29% against the U.S. currency. The greenback, however, has risen 0.45% versus the yen.
"In line with a sense of profit-taking, 'risk-on' trades look set for a correction today," Rodriguez said, in a research note.
Rising risk appetite has been a driving factor behind rising equity prices since March, while also lifting commodities and higher-yielding currencies. The dollar, which had benefited from its safe-haven status as the financial crisis and global recession took hold, has tended to fall during periods of rising risk appetite.
Indications the greenback is becoming increasingly attractive as a "funding currency" for carry trades has put added pressure on the U.S. unit, with dollar bears expecting the currency to see renewed weakness.
Carry trades are centered on borrowing in a low-yielding currency and investing in higher-yielding currencies.
"Lingering uncertainty [about] the huge U.S. financing needs together with the Fed's intention to run an expansionary monetary policy for a prolonged period of time offer additional ammunition for carry traders to use the dollar rather than other currencies," wrote strategists at KBC Bank in Brussels.
"This has put the dollar in a vulnerable position. We don't see many reasons to turn dollar positive before it becomes clear that the Fed will take the lead in tightening monetary policy," they wrote.
The Fed's rate-setting Federal Open Market Committee meets Tuesday and Wednesday. Analysts expected no change to the central bank's target overnight lending rate between banks, but speculate whether the fed will make changes to its debt-buying programs. See Bond Report.
British pound, Chinese yuan
Meanwhile, worries about the strength of the financial sector were back in bloom after news reports late Thursday said Britain's Financial Services Authority had rejected a proposal from Lloyds Banking Group (UK:LLOY 110.10, +0.21, +0.19%) to exit the Asset Protection Scheme. The decision was reportedly due to concerns the bank wouldn't be able to raise enough capital on its own. See full story.
The British pound dropped more than 15, with sterling trading at $1.6279. The euro pushed above the 90-pence level for the first time since May, trading up 0.7% at 90.30 pence.
The pound has also suffered from perceptions it may join the dollar as a preferred funding currency for carry trades.
The currency had little direct reaction to data showing government borrowing soared in August. Analysts said sluggish preliminary money supply data for August raised questions about whether the Bank of England will need to further ramp up its money-creating quantitative easing program, a potential negative for sterling.
Chinese authorities, meanwhile, may be about to loosen the reins on the nation's currency, allowing appreciation against the U.S. dollar to resume, although the pace could be slower than it was before the financial crisis, analysts said. See full story.
On Friday, the yuan edged lower as businesses shut early in Beijing as the capital prepares for the final rehearsal of National Day celebrations. The yuan ended at 6.8282 against the dollar in over-the-counter trade in Shanghai, down from Wednesday's 3 1/2-month closing high of 6.8260 to the dollar, according to Dow Jones Newswires.
