• The offshore yuan rebounded to 7.1845 per dollar as of midday, up from a record low of 7.1966 hit overnight.
• Sino-US trade tensions have been the main source of yuan weakness, as many investors believed bilateral relations would deteriorate further, said a trader at a Chinese bank.

Hostile diplomacy between the world's two largest economies intensified with China expected to pass a controversial national security law on Hong Kong. China's National People's Congress is set to vote on the draft law at the end of its annual session on Thursday.

The offshore yuan rebounded to 7.1845 per dollar as of midday, up from a record low of 7.1966 hit overnight.

Washington is currently crafting a range of options to punish China over its tightening grip on Hong Kong, including sanctions, tariffs and restrictions on Chinese companies, according to people familiar with the discussions.

"Sino-US tensions are dialing up, but up till now, it has not broadened to affect actual trade and portfolio flows between the countries," said Terence Wu, strategist at OCBC Bank.

Wu said he expected a test of the 7.2000 level sometime in the future, but expected the PBOC to slow the approach to that level, as it did with Thursday's stronger-than-expected daily fixing.

Prior to market opening, the People's Bank of China set the yuan's midpoint rate at 7.1277 per dollar, weaker than the previous fix of 7.1092, but much firmer than market projections.

Several traders said yuan depreciation expectations have picked up, with increasing queries from corporate clients about whether they should buy dollars now.

"Markets are watching if US President Donald Trump would really take powerful actions," said a chief dealer at a Chinese bank, adding that the domestic currency market would be also influence by how the broader dollar index performs.

Sino-US trade tensions have been the main source of yuan weakness, as many investors believed bilateral relations would deteriorate further, said a trader at a Chinese bank.

"Markets are now seeing increasing chances that the PBOC will allow its currency to depreciate further in reaction to the possible US sanctions," strategists at ING said in a note.

The onshore yuan was little changed at 7.1677 at midday, 3 pips firmer than the previous late session close.