Photo/Illutration People wearing face masks stand near a bank electronic board showing the Hong Kong share index at Hong Kong Stock Exchange on May 26. (AP Photo)

The dollar edged higher on Wednesday as worries about the U.S. response to China’s proposed security law for Hong Kong supported safe-haven demand for the greenback.

The euro held gains against the dollar and the pound but faces a severe test when the European Commission is expected to release details of a financial rescue fund for the bloc later on Wednesday.

Financial markets have been caught in a tug-of-war between optimism and pessimism about the global outlook.

Some investors are betting on a resumption of normal economic activity following the crippling coronavirus pandemic, but others worry the threat of U.S. sanctions against China for its treatment of Hong Kong could easily worsen risk sentiment yet again.

“We are in a broad risk-on trend, but the only thing that can change this is the U.S.-China relationship,” said Junichi Ishikawa, senior FX strategist at IG Securities in Tokyo.

“More problems between these two countries would slow the dollar’s recent decline and potentially lead to dollar buying as a safe haven.”

The dollar edged up to $1.2321 against the pound on Wednesday in Asia, pulling away from its lowest level in two weeks.

The dollar traded at $1.0983 per euro, close to a one-week low.

It bought 0.9655 Swiss franc in Asia, nursing a 0.6 percent loss in the previous session.

The Australian dollar fell 0.3 percent to $0.6636, while the New Zealand dollar fell 0.2 percent to $0.6185 as worries about U.S.-China tensions hurt demand for riskier assets.

The Aussie and the kiwi are often traded as liquid proxies for risk because of their close ties to China’s economy and global commodities.

The dollar remained locked in a narrow range against the Japanese currency, trading at 107.51 yen.

Many of the places that were hardest hit by the coronavirus pandemic are now allowing more businesses to resume normal operations, causing investors to unwind safe-haven bets and push the dollar lower on Tuesday.

However, the move faded on Wednesday as Asian stocks fell and U.S. Treasury yields fell, showing risk aversion remains a factor.

U.S. President Donald Trump said on Tuesday the United States will announce before the end of the week its response to China’s planned security bill for the former British colony of Hong Kong.

Trump’s administration is considering sanctions on Chinese officials, Bloomberg News reported.

The United States and China have repeatedly clashed over trade policy, advanced technology, and China’s response to the coronavirus, which originated in the central province of Hubei late last year.

Another row between the world’s two superpowers over civil liberties in Hong Kong could prompt a return to risk-off trades that favor dollar gains, declining equities and rising bond prices.

Further gains in the euro depend on whether policymakers can narrow their differences on how to fund an economic rescue package for the euro zone, traders say.

France and Germany have proposed a 500 billion euro coronavirus recovery fund that would issue grants to help the bloc’s economic recovery from the coronavirus pandemic.

Austria, Sweden, Denmark and the Netherlands have opposed this plan, calling instead for a loans-based approach.

The European Commission is to present its own proposal for a recovery fund later on Wednesday, which could determine the near-term direction of the euro.

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