The dollar fell to a one-week low on Tuesday as investors unwound long bets on the currency, anticipating the Federal Reserve could slow the pace of U.S. interest rate hikes after this week's policymaking meeting.
The greenback weakened for a second straight session. A rout on Wall Street on Monday, recent mixed U.S. and global economic data, and persistent market volatility have bolstered a view that the Fed's widely expected rate hike on Wednesday could mark the end of three years of steady rate increases.
U.S. President Donald Trump's critical comments on the Fed did not help the dollar's cause either.
In a tweet overnight, Trump took another swipe at the Fed, saying it was "incredible" for the central bank to even consider tightening policy given the global economic and political uncertainties.
"While (the Fed) remaining on hold would be a significant surprise and a significant U.S. dollar-negative, there is little doubt that equity market volatility is creating some headaches for policymakers," said Shaun Osborne, chief FX strategist, at Scotiabank in Toronto.
Osborne noted that Fed rate hike expectations have slipped, with markets now pricing in a 70 percent chance of a rate increase, down from a 78 percent chance on Monday.
"That is quite a significant move right ahead of the policy decision," he said.
Investor confidence has deteriorated, leading to the gloomiest outlook for the world economy in a decade, a survey by Bank of America Merrill Lynch found.
The dollar has replaced technology stocks as the most crowded trade for the first time since January, it said.
The dollar index fell 0.09 percent lower at 97.01 at 12:55 p.m. ET, after earlier sliding to its weakest since Dec 10.
Some analysts think dollar strength will return if the Fed remains confident about next year's monetary policy tightening path.
"Personally, I think the Fed will continue to normalize policy next year and I don't think it will send the U.S. economy into recession," said ACLS analyst Marshall Gittler.
Risk-off sentiment on Tuesday lifted the Japanese yen and Swiss franc.
With the prospect of a "dovish rate hike" keeping the dollar in check, the euro on Tuesday rose 0.16 percent to $1.1364. It has recovered all of its losses from Monday when it was hit by weak euro zone data.
Still, the European Central Bank's assessment last week that the balance of risks was moving to the downside, combined with protests in France weighing on business, means euro appreciation is still a few months away, Goldman Sachs analysts said.