* Euro, yuan build on Monday’s gains
* Inversion in U.S. yield curve dents dollar
* Yen up more than half a pct
* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
By Tommy Wilkes
LONDON, Dec 4 (Reuters) - The euro extended its rally on Tuesday as a fall in U.S. Treasury yields encouraged further selling of the dollar, while the yen and trade-linked currencies including the Chinese yuan also rose.
Investor jitters about China and the United States’ ability to resolve their trade differences did not spread into the foreign exchange market, with emerging market currencies and the Australian and Canadian dollars mostly building on Monday’s gains.
U.S. Treasury yields fell overnight, with short-dated rates higher than longer term rates. Yields on two maturities at the front of the curve rose above longer-dated 5-year notes for the first time in more than a decade.
The yield curve has flattened as continuing interest rate hikes send short-dated yields higher, while longer-dated Treasury yields are kept down by tepid inflation and slowing global growth.
The so-called “inversion” of the yield curve is the first since the beginning of the financial crisis in 2007 and to many investors sounded an alarm about a looming U.S. economic slowdown.
“Clearly investors think the Fed(eral Reserve) is going to become more cautious and data dependent with rate hikes. We are basically approaching the end of the rate hiking cycle. That is negative for the dollar,” said Esther Reichelt, FX strategist at Commerzbank.
The dollar index dropped 0.4 percent to 96.638, while the euro added 0.3 percent to $1.1386.
Reichelt said that despite the headwinds for the dollar, without a resolution of a dispute between the European Union and Italy over the latter’s budget plans, or euro-specific positive developments, euro/dollar would likely trade in a range of $1.12 to $1.16.
The recent weakness in the dollar comes against the backdrop of a temporary truce in the US-China trade conflict agreed over the weekend, which has bolstered investor confidence in riskier currencies versus the safe-haven greenback.
The dollar fell 0.5 percent against the offshore yuan to 6.8421 on Tuesday, its weakest level since September. On Monday, the dollar lost 1.07 percent against the Chinese currency, its steepest percentage fall since Aug. 25.
“For now, it seems China has got the best out of G20 and we expect the yuan to remain supported,” said Nick Twidale, chief operating officer at Rakuten Securities.
However, he said markets needed to see a further easing in trade tensions for the rally to continue.
The Australian dollar benefited from the broad-based dollar selling, gaining 0.3 percent in Asian trade at $0.7384. The Reserve Bank of Australia kept its policy cash rate unchanged on Tuesday in a widely expected move.
The yen gained 0.6 percent to 112.94 yen per dollar.
Emerging market currencies including the Mexican peso and Indian rupee were mostly up against the dollar. (Additional reporting by Vatsal Srivastava in Singapore; Editing by Andrew Heavens)