The US dollar tumbled to four-month lows on Thursday against a basket of currencies, amid escalating tensions between China and the US. The currency has continued its fall in the backdrop of a wait and watch investor attitude.

"Retaliation for the Houston closure is now widely expected - the relative severity of which will offer markets some guidance on Beijing's engagement strategy into the 2020 elections," said UBS strategists in a note to clients.

Following allegations of spying, China was given until Friday by the US to shut its consulate in Huston. While China has affirmed a response to the demand, the rising tensions between the two gargantuan economies led to the sharpest decline of the yuan in nearly two months on Wednesday.

Bouncing Back Against A Weak Dollar

"US-China tensions generate volatility, but it is the stimulus and recovery dynamic that we expect will prove more dominant," they added. UBS forecast the yuan - a barometer of Sino-US relations - would reach 6.8 per dollar by the end of 2020, and 6.7 by the first half of 2021.

US Banknotes
Representational Picture Xinhua/Liu Jie/IANS

The index that measures the dollar against peer currencies hit its lowest since March 9. The dollar index has lost nearly 8 percent since its March 20 peak, when a global dollar funding crunch saw a surge in demand. It is down 1.5 percent year-to-date.

US-China ties have deteriorated this year over issues ranging from the new coronavirus and telecoms-gear maker Huawei, to China's territorial claims in the South China Sea and Hong Kong crackdown. The US State Department said the Chinese mission in Houston was being closed "to protect American intellectual property and Americans' private information."

A Political Ploy, Says China

Chinese state media said on Thursday the move was a political ploy ahead of November presidential elections, and one source with knowledge of the matter told Reuters China was considering closing the US consulate in Wuhan in response.

"If China does limit its retaliation to closing the Wuhan consulate, the market will probably take it in stride, but if China instead decides to do something that escalates the tensions between the two countries, we could quickly switch to a 'risk-off' mood," said Marshall Gittler, head of investment research at BDSwiss Group.

Against the safe-haven Japanese yen, the dollar was flat at 107.15. The euro was at $1.1573, just below a 21-month high of $1.1601 hit earlier this week after Europe's leaders agreed on a recovery fund. The Australian dollar retreated from a 15-month peak to around $0.7151, while the kiwi was just below Wednesday's six-month top of $0.6678.

(With inputs from agencies)