SINGAPORE, May 19- The dollar held at around six-month highs against the yen and seven-week highs against the euro on Friday, as optimism over a breakthrough in U.S. debt ceiling talks and robust economic data reduced the chances of a series of U.S. rate cuts this year.
Negotiators for Joe Biden's Democrats told the president on Friday that they are making "steady progress" in talks with Republicans aimed at avoiding a U.S. default, just days after Biden and top U.S. congressional Republican Kevin McCarthy underscored their determination to strike a deal to raise the government's $31.4 trillion debt ceiling.
That eased fears of an unprecedented and economically catastrophic default, leading markets to revise their expectations of where U.S. interest rates could go.
At the same time, data pointing to a still-tight labour market, with the number of Americans filing new claims for unemployment benefits falling more than expected last week, also raised expectations that the Federal Reserve could raise rates again next month to tame inflation.
The dollar index traded at its highest in two months, having risen by nearly 2.5% in the last two weeks alone, as investors have rushed to reassess their expectations for what the central bank might do next.
"The message from the Fed has been really hawkish. We know there has been this divergence between what the market's expecting and what the Fed has actually been saying and that was always going to need to be reconciled at some point. We're starting to see this play out in the FX market now," City Index strategist Fiona Cincotta said.
"As far as expectations for a June rate hike are concerned, those have risen significantly in the last week. The market is pricing in a 40% chance and that is up from 15% a week ago," she said.
Two Fed policymakers said on Thursday that U.S. inflation does not look like it is cooling fast enough to allow the Fed to pause it is tightening campaign.
Money markets show traders now believe U.S. rates will fall to around 4.86% by year-end, compared with an expectation for a drop to 4.25% just two weeks ago - reflecting how the chances of a flurry of rate cuts have dropped.
The dollar ceded some ground on Friday but still held firm. Against the yen, the dollar was down 0.4% at 138.19 yen, having risen to a six-month peak of 138.745 earlier on.
The euro was flat on the day at $1.0773, near its lowest for seven weeks, while the sterling eased 0.1% to $1.239, its lowest in a month. The pound lost 1.4% in value against the dollar in May, largely because of the diverging interest-rate outlook in Britain and the United States.
Among other major currencies, the Australian dollar took some heart from a pickup in commodity prices like copper and iron ore. The Aussie rose 0.3% to $0.6644, while the New Zealand dollar rose 0.7% to $0.6258.
In China, the yuan slid to its lowest since December, at 7.0365 per dollar, as data offered evidence of a sputtering recovery in the world's second-largest economy.
"(Yuan) softness started after China activity data disappointed," said Christopher Wong, a currency strategist at OCBC. "The depreciation gathered traction following the breach of 7.00 and there appears little signs of pushback from policymakers on the rapid pace of decline."