Asian markets rose Tuesday but early gains were pared in a muted reaction from investors after the US government partially closed down as Congress missed a deadline to agree a new budget.
The dollar bounced back from Monday's lows in Japanese forex trading despite the impasse in Washington that President Barack Obama has warned will hit a budding recovery in the world's biggest economy.
Investors also took heart from data showing Chinese manufacturing activity at its strongest in 17 months, adding to hopes a slowdown has come to an end.
Tokyo rose 0.60 percent, Singapore gained 0.57 percent and Sydney was up 0.10 percent, while Seoul was flat. Hong Kong and Shanghai were closed for a public holiday.
The US government shut down at midnight Washington time (0400 GMT) as Republicans and Democrats refused to give ground to reach a budget deal.
World markets had expected the deadline to pass with no breakthrough and shares had fallen in previous sessions.
The US closure will see about 800,000 federal staff told to stay at home, leading to the closure of numerous agencies in the first shutdown since 1996.
Obama accused Republicans of holding America to ransom with their "extreme" political demands for his flagship healthcare law to be delayed for a year before they give the go-ahead to any budget.
In a peech to US troops to tell them they would continue to be paid, Obama said: "Unfortunately, Congress has not fulfilled its responsibility, it has failed to pass a budget."
Tracey Warren of CMC Markets Stockbroking told Dow Jones Newswires: "A prolonged shutdown could have a major impact on confidence and on the US economy, and will likely see a delay in the release of (US) employment figures."
Adding to the sense of crisis, the two sides appear unlikely to reach a deal to lift the US borrowing limit by mid-October, when the government runs out of cash, leaving it unable to service its debts and in turn possibly default.
In Japan, the central bank's quarterly Tankan survey surged to its strongest level since December 2007 with a reading of "plus 12" from "plus 4" in its last survey, showing that major manufacturers are confident about future prospects.
Prime Minister Shinzo Abe is Tuesday expected to announce a sales tax hike seen as crucial to cutting Tokyo's huge national debt, but which critics say could derail a recovery in Japan.
Jiji Press reported that Abe has decided to increase the tax from 5.0 percent to 8.0 percent.
He told a meeting of government and ruling party policymakers that the increase was aimed at "maintaining the nation's trust and handing over a sustainable social security system to the next generation", Jiji reported.
The premier is also expected to unveil a stimulus package to help soften the blow, which has put downward pressure on the yen.
In afternoon Tokyo trade the greenback was at 98.24 yen, up from 98.21 yen in New York and much stronger than the levels around 97.80 yen seen in Tokyo on Monday.
The euro bought $1.3544 compared with $1.3524, while it also fetched 132.95 yen against 132.81 yen.
In China the official purchasing managers' index of manufacturing activity crept up to a 17-month high of 51.1 last month from 51.0 in August, the National Bureau of Statistics (NBS) said on its website.
A reading above 50 indicates expansion while anything below signals contraction.
It is the latest in a series of of recent data indicating the Chinese economy is picking up steam after suffering a slowdown in the first half of the year.
A separate survey by HSBC came in a 50.2 on Monday, up from 50.1 in August and much higher than an 11-month low of 47.7 in July.
On oil markets, New York's main contract, West Texas Intermediate for delivery in November, fell 38 cents to $101.95 in mid-morning trade, while Brent North Sea crude for November dipped 33 cents to $108.04.
Gold cost $1,328.32 at 0500 GMT compared with $1,340.86 on Monday.