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Dollar Rebounds as Strong Data Point to Fed Unwinding

Don Farrall | Photographer's Choice RF | Getty Images

The dollar rebounded against the euro and yen Tuesday after robust U.S. economic data reinforced expectations the Federal Reserve may start unwinding its stimulus program over the next few months.

Wall Street posted sharp gains, while benchmark U.S. 10-year Treasury yields rose to their highest in more than a year after the data, suggesting the world's largest economy was on a steady road to recovery. Higher Treasury yields have also boosted the appeal of dollar-denominated investments.

Gains in these assets were triggered by a U.S. consumer confidence index which increased in May to its highest in more than five years. That private-sector report on Tuesday followed data showing single-family home prices rose in March, racking up their best annual gain in nearly seven years.

(Read More: Soaring Consumer Confidence Points to US Resilience)

"Stronger-than-expected U.S. data brought the Fed a step closer to cutting back on stimulus as soon as the next few policy meetings," said Joe Manimbo, senior market analyst, at Western Union Business Solutions in Washington.

The Fed's stimulus program is viewed as negative for the greenback because it involves flooding the market with dollars.

In late afternoon trading, the dollar fell 0.6 percent vs. the euro to $1.2852 after the data's release.

(Read More: Home Price Gains Go to Double Digits)

Sean Cotton, vice president and foreign exchange advisor at Bank of the West in San Ramon, Calif., said prospects of negative interest rates "remain the new albatross around the neck of the region."

European Central Bank Governing Council member Christian Noyer said in a Bloomberg TV interview on Tuesday that negative interest rates will have different results across the smaller countries, but he added that the bank should be prepared to implement them if necessary.

"As the ECB continues to push into uncharted territory, the policy outlook is likely to produce further declines in euro/dollar," Cotton said.

Also on Tuesday, European Central Bank Executive Board member Peter Praet said the bank could still cut interest rates further if needed, a day after ECB Executive Board member Joerg Asmussen said the loose policy would stay as long as necessary.

Yen Tumbles

Against the yen, the dollar rose 1.4 percent to 102.38 yen after hitting a session high of 102.50, rebounding from a two-week low of 100.68 set on Friday. The dollar rose to a 4 1/2-year high of 103.73 yen last Wednesday.

The yen tumbled broadly as global equity markets rallied on supportive comments from central bankers, encouraging investment in riskier, higher-yielding trades funded by cheap borrowing in the Japanese currency.

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Japan's Nikkei stock average ended 1.2 percent higher, while European and U.S. shares rallied, reversing sharp losses seen last week after Fed Chairman Ben Bernanke ignited expectations the U.S. central bank may scale back its stimulus.

(Read More: Japan's Nikkei—Stable Now, but for How Long?)

Bank of Japan board member Ryuzo Miyao said on Tuesday it was vital to keep long- and short-term interest rates stable.

Strategists said markets were positioned for yen weakness on expectations of aggressive monetary easing by the Bank of Japan. They said the yen's reluctance to gain further in the face of equity selloffs late last week suggests its weakening trend remains intact.

"Perhaps the most interesting aspect of the price action is the degree to which dollar/yen is holding up despite significant position reduction into the long weekend," said Jens Nordvig, global head of FX strategy at Nomura Securities.

"We are just 1.5 percent away from the highs in dollar/yen, even if the Nikkei is more than 10 percent off the highs. We are sticking with our long dollar/yen position with a stop at 100.50."

The euro rose 0.9 percent to 131.62 yen, pulling away from Thursday's trough of 129.94 yen.

The safe-haven Swiss franc fell, with the dollar up 1.5 percent at 0.9778 franc and the euro up 0.9 percent at 1.2569 francs.

Currencies such as the yen and the Swiss franc, which rose sharply last week after a recent selloff in stock markets, typically gain in times of financial uncertainty.

The dollar index, which measures the greenback versus a basket of currencies, rose 0.7 percent to 84.26.

The higher-yielding Australian and New Zealand dollars failed to benefit from the broad rally in equity and commodity prices.

(Read More: More Rates Cuts in Australia? Here's Why Not)

The Australian dollar was last at US$0.9616, little changed on the day, while the New Zealand currency was slightly up at US$0.8076. Analysts cited uncertainty about the outlook for China's economy.