By Chikako Mogi
TOKYO (Reuters) - The dollar rose on Monday as the prospect of an improving U.S. economy that has prompted the Federal Reserve to consider toning down its stimulus drive in coming months, but Asian shares were capped as investors adapted to the Fed's evolving plan.
The dollar was up 0.5 percent against the yen at 98.38, slowly extending gains and moving away from its 10-week low of 93.75 yen hit earlier in the month.
After speculators cut back on massive short yen positions built on overdone expectations for the rapid success of Japan's new economic policies, traders said the prospect of diverging yield directions will support the dollar against the yen.
The benchmark 10-year U.S. Treasuries yield rose as high as 2.542 percent on Friday, the highest since August 2011. For the week, the 10-year yield was on track to rise 40 basis points for the biggest single-week jump since March 2003.
"A better economic outlook will eventually need to be priced into the short end of the yield curve. This suggests that there is a catch-up trade for the USD versus low-yielding currencies (such as the yen)," Barclays Capital said in a research note.
Against a basket of major currencies, the dollar index <.dxy> rose 0.31 percent to a two-week high after ending last week up 2.2 percent for its biggest weekly gain since early November, 2011.</.dxy>
MSCI's broadest index of Asia-Pacific shares outside Japan <.miapj0000pus> was nearly flat after ending Friday down 0.8 percent at a 9-1/2-month low and posting a weekly loss of 4.5 percent, its worst weekly drop since May 2012.</.miapj0000pus>
Australian shares <.axjo> eased 0.3 percent while South Korean shares <.ks11> opened down 0.1 percent after hitting a 11-month low on Friday.</.ks11></.axjo>
"U.S. markets ended firm, so this will give our market the opportunity to firm its support at the current level," said Lee Jae-mahn, a market analyst at Tong Yang Securities, of Seoul shares.
Japan's benchmark Nikkei stock average <.n225> opened up 1.4 percent, with sentiment boosted by the weaker yen. <.t></.t></.n225>
U.S. equities stabilized in choppy trading on Friday but the FTSEurofirst 300 <.fteu3> index of top European shares ended at its lowest level since December on Friday, suffering its biggest weekly drop in more than a year of 3.7 percent.</.fteu3>
Financial markets were sold off last week after Fed Chairman Ben Bernanke said that with the U.S. economy showing signs of recovery, the central bank may start scaling back its huge monthly bond-buying plan which was aimed at keeping bond yields down and supporting the economy. The Fed's strong accommodative stance has also encouraged investment in riskier assets such as shares.
As investors began to grapple with the perceived reversal in fund flows as a result of the Fed's shift in policy, they faced additional jitters from China, where recent economic data has raised concerns about a growth slowdown and falling demand for commodities.
Money market volatility in China also unnerved investors.
China's central bank has over the past week refused to inject funds, letting short-term money market rates spike to extraordinary levels and fuelling speculation about problems in the Chinese banking system.
Many analysts saw the People's Bank of China's withholding of money market funding as a stratagem to force banks to stop channeling cash into the informal banking sector, known as "shadow banking", which authorities worry is creating significant credit risks.
Spot gold was up 0.2 percent at $1,299.36 an ounce, after touching its lowest since September 2010 of $1,268.89 on Friday and ending the worst week in nearly two years.
U.S. crude futures inched up 0.1 percent to $93.77 a barrel.
(Additional reporting by Jungyoun Park in Seoul; Editing by Eric Meijer)