The dollar slipped against the major currencies on Tuesday as US bond yields continued to fall from five-year highs hit last week, eroding their appeal to foreign investors. At the same time, the euro retreated from a record peak against the yen and treaded water against the dollar after a surprise decline in German business confidence in June.
In recent weeks, the dollar has closely tracked Treasury yields, hitching a ride higher as strong US economic data boosted the benchmark 10-year note's yield to 5.33 percent and sent the euro to nearly a three-month low against the greenback. But with little major US economic data on tap this week to guide traders, a bond market retracement has curbed the dollar's gains and weakened the case for the Federal Reserve to boost interest rates in 2007.
"We have a light calendar this week and there's no real catalyst providing a fresh reason to buy dollars," said Bank of New York strategist Michael Woolfolk. That leaves "significant gyrations in bond prices" to lead some price action, he said.
Higher US Treasury yields imply higher interest rates and tend to attract return-hungry investors into US assets. But since closing at 5.29 percent a week ago, 10-year yields have slipped nearly 20 basis points over the past five sessions, the bond market's best five-day stretch in more than three months.
The spread of the implied US interest rate in December 2008 over the euro zone's has narrowed to about 60 basis points from 70 basis points last week, according to futures markets.
By late afternoon in New York, the dollar was down 0.2 percent at 123.32 yen. Sterling was up 0.3 percent at $1.9885 per pound. An unexpected slide in Germany's ZEW business sentiment index on Tuesday kept the euro's gains more modest, rising 0.1 percent to $1.3423.
The ZEW report also knocked the euro down 0.2 percent to 165.55 yen after earlier hitting a record peak above 166 yen. Markets are still expecting at least two more interest- rate hikes from the European Central Bank this year, while the Fed is seen leaving rates steady at 5.25 percent for 2007.
"The euro wants to trade higher but can't because of selling pressure in euro/yen," said Brian Dolan, head of research at Forex.com, in Bedminster, New Jersey.
Despite the yen's mild rise on Tuesday, market sentiment remained positioned against the currency as investors continued to borrow it at low Japanese interest rates in order to buy higher-yielding currencies.
Hiroshi Watanabe, Japan's vice finance minister, said Tuesday he was watching speculative yen carry trades carefully but said they do not as yet pose a risk to Japan's economy. He also said Japan has no plans to diversify its foreign- exchange reserves away from dollars any time soon.
Bank of New York's Woolfolk, however, said it would be a mistake to expect yields and the dollar to march in lockstep indefinitely, adding there are other reasons for the dollar's weakness as well, including a push higher in oil prices. Indeed, commodity currencies such as the Canadian and New Zealand dollars have been among the biggest gainers on the day. "We should not confuse correlation with causation," he said.