The dollar retreated sharply to 3-week lows in Asia on Tuesday as speculation over global interest rate hikes curbed dollar demand.

The main market focus over the past 24 hours has been inflation pressures and potential central bank responses, especially given supply-side pressures. US yields overall moved higher, although long-term yields drifted lower. Reflation trades gained fresh traction on Tuesday with demand for commodities.

The dollar retreated sharply to 3-week lows in Asia on Tuesday as speculation over global interest rate hikes curbed dollar demand. EUR/USD moved back above 1.1600 to around 1.1650. Sterling failed to hold initial gains, although GBP/USD moved back above 1.3750 to 1-month highs as the dollar retreated.  The Canadian and Australian dollars posted fresh gains on Tuesday with AUD/USD at 6-week highs.

US industrial production declined 1.3% for September after a downwardly revised 0.1% fall for August and substantially below consensus forecasts of a 0.2% increase. Activity was hampered by supply issues surrounding semiconductors and overall activity on the month was also dragged lower by declines in mining and utilities output. Capacity use also declined to 75.2% from 76.2% previously. The industrial data has tended to have a muted reaction over recent months, but the much weaker than expected data did have some impact in undermining confidence, especially with on-going supply shortages.

The NAHB housing index strengthened to 80 for September from 76 previously and above market expectations which had little impact.

The dollar continued to drift lower after the Wall Street open, although overall moves were mixed with markets tending to focus on interest rate expectations among other major global central banks. EUR/USD moved back above the 1.1600 level, although with a lack of any significant momentum.

The latest business confidence data from the US and Euro-zone will be released on Friday with markets looking to assess the relative outlook.

The dollar dipped sharply during Tuesday’s Asian session with an element of concern that the US out-performance would fade, especially given supply constraints. There was also a wider US correction, amid expectations that other global central banks would also engage in policy tightening over the next few months.

The dollar index retreated to 3-week lows and EUR/USD secured a further net recovery to just above 1.1650 as commodity currencies also posted net gains.

There was a significant increase in medium-term bond yields during the day, although the 10-year yield drifted slightly below the 1.60% level. Wall Street equities opened lower, but there was a move into positive territory at the European close.

USD/JPY found support close to 114.00 against the yen and gained some ground as yields moved higher, but the advance was halted around 114.40.

Markets remained wary over the risk of a sharp correction given the over-extended short yen positioning. US Treasury Secretary Yellen also stated that the US would extend extraordinary debt management measures with a longer-term debt limit still not agreed by Congress.

The Japanese general election will be held on October 31st, but there was little underlying impact on currency markets. Equity markets were able to make headway in Asia on Tuesday which eroded potential defensive demand for the dollar and yen. Overall, USD/JPY retreated to around 114.10 with net EUR/JPY gains to 133.0.

UK yields continued to move higher in early Europe on Monday as the 2-year yield increased sharply to above 0.70% compared with a level around 0.25% in md-September. Yields were boosted by strong expectations that the Bank of England would opt for an early increase in interest rates to curb inflation.

There was, however, significant retracement later in the day with markets also fretting over the threat of damage to the economic recovery.

The potential for higher yields in other major economies was also a significant factor curbing the potential Sterling relative advantage and the UK currency lost ground. GBP/USD settled around 1.3725 with GBP/EUR dipping to 1.1820 with traders paring long positions.

Reaction to the latest inflation data will be watched very closely on Wednesday to assess whether the Bank of England will push ahead with an early tightening. Dollar weakness dominated in Asia on Tuesday with GBP/USD advancing to 1-month highs around 1.3775 with GBP/EUR close to 1.1820.

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