NEW YORK (Reuters) - The dollar sagged against the safe-haven yen and low-yielding euro on Tuesday as weak Chinese factories data drove investors to unwind bets against the two currencies widely used to fund positions in riskier assets.
The data showed the manufacturing sector of the world's No. 2 economy shrinking at its fastest in three years, aggravating wide worries about world growth and igniting sell-offs in equities markets large and small. Wall Street's S&P 500 Index .SPX was down 2.5 percent.
Speculators and investors had sold low-yielding currencies to buy higher-yielding ones and shares for better returns, so a worsening outlook for stock markets and the global economy tends to reverse that process.
"Most of these hedged positions are over-hedged and they have to buy the currencies," said Mark McCormick, a strategist at Credit Agricole in New York. "We're of the school that you buy the dollar on dips."
The dollar was last off 1.20 percent to 119.80 yen JPY=, having retreated from a high of 121.76 yen set late last week. The euro rose 0.70 percent to $1.1297 EUR=, extending its recovery from last week's one-week low of $1.1156.
The dollar was also down against the Swiss franc and the British pound, while the dollar index .DXY was off 0.40 percent.
"Concerns about China are a key drive in currency markets and the PMIs were weaker and not good for overall risk sentiment," said Yujiro Goto, currency strategist at Nomura.
A PMI report for the United States by the Institute for Supply Management showing softness in American factories briefly added to the dollar's weakness.
With China moving to clamp down on speculation in the currency forwards market, analysts expect markets to stabilize in coming days. That in turn could see the focus return to U.S. data, including a jobs and wages report due on Friday.
Doubts over whether the Federal Reserve will raise interest rates this month in the context of persistent market turbulence have weighed on the dollar in recent weeks. But comments from the U.S. central bank's vice chairman, Stanley Fischer, last week suggested a rate hike in September was still an option.
BNP Paribas analysts expect an above-consensus 230,000 increase in U.S. jobs and a steady unemployment rate of 5.3 percent. While that would not be enough to force a September hike, there was scope for the U.S. bond yield curve to turn more dollar supportive.
Reporting by Michael Connor in New York; Editing by Cynthia Osterman