Against the traditionally safe-haven yen, the greenback slid 0.8 percent to 119.78 yen, pulling further away from a seven-year high of 121.86 yen set on Monday. The Japanese currency also rose versus the euro, which shed 0.5 percent to around 147.93 yen.
"Currency markets are trading in a risk-off sentiment," said Neil Jones, head of FX hedge fund sales at Mizuho bank in London, adding that investors were booking profits on the dollar into the year-end after its strong performance in recent months.
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"People are cutting the higher yielding currencies which they've been funding through being short yen and that position is being reversed somewhat, which is manifesting itself in a much lower dollar/yen."
The U.S. dollar may retreat further versus the yen in the near term due to the potential for more position squaring in the wake of its recent rally, said Masashi Murata, currency strategist for Brown Brothers Harriman in Tokyo.
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"The size of volatility in the dollar's moves versus the yen has become quite stark," Murata said, adding that choppy trading conditions could persist toward the year-end.
The euro rose by 0.4 percent to $1.23620, moving further away from a 28-month low of $1.2247 hit on Monday as the dollar weakened across the board.
Against a basket of major currencies, the dollar fell 0.3 percent, having hit a five-year high on Monday.