Dollar eases, Fed policy path on interest rates in focus

The dollar index, which measures the US currency against six others, fell 0.06% to 104.39, having touched 104.60 on Monday, its highest since Nov. 14.

The dominant storyline for FX traders is a return to the US economic exceptionalism trade that was seen in last year's third quarter, said Matthew Weller, global head of research at FOREX.com.

"Now traders are wondering if instead of whether we'll get a soft landing or recession, whether we could have no landing or re-acceleration this year," he said. "To me it is a lot about the US dollar, the Fed and the economic data that we're seeing out of the US"

Key to that view is the outlook for interest rates and how high they stay, as higher yields help bolster a currency.

"The real debate is not if the Fed cuts a few weeks sooner or later, but if it cuts by less or more than the rest of the world over the next two years," said George Saravelos, global head of forex research at Deutsche Bank.

"We continue to see the risks skewed towards less Fed easing and therefore in favor of the US dollar," he added.

The euro was flat at $1.0742%.

German industrial orders unexpectedly jumped in December, while euro zone consumers have trimmed their expectations for inflation over the next 12 months.

"A potential repricing of the ECB (European Central Bank) policy path towards a first rate cut in June instead of April, which we regard as likely, would prop up the euro in the medium term," said Roberto Mialich, forex strategist at UniCredit.

The Reserve Bank of Australia (RBA) earlier on Tuesday left rates unchanged, but cautioned about a possible further monetary tightening.

The Aussie rose 0.31% to $0.6503, inching away from the 2-1/2 month low of $0.6469 it touched on Monday.

The repricing of the RBA monetary path "helps to provide modest support for the Australian dollar in the near-term," said Lee Hardman, senior currency analyst, at MUFG.

"Sentiment towards the Aussie has also been boosted indirectly overnight by the rebound in the Chinese equity market where speculation is building over further state policy action to provide stability," he added.

Sterling last fetched $1.2582, up around 0.37% on the day, but remained close to Monday's seven-week low.

The pound's fall on Monday came despite some upbeat economic data. Figures showed that UK unemployment was likely much lower late last year than previously thought, which could push out British rate cuts too.

The Japanese yen was stronger on the day at 148.250 per dollar, but not far off a two-month low of 148.90.

Japan's real wages fell for a 21st straight month, though at a slower pace, while household spending dropped for a 10th consecutive month, showing inflation outpaced wage recovery and continued to weigh on consumer spending.