December 4, 2018 / 11:13 AM / 9 days ago

FOREX-Euro rises as Treasury yield drop whacks dollar; yuan at 2-month high

* Euro, yuan build on Monday’s gains

* Inversion in U.S. yield curve dents dollar

* Yen up nearly 1 pct

* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh (Adds details, quotes, updates FX prices)

By Tommy Wilkes

LONDON, Dec 4 (Reuters) - The euro rallied above $1.14 on Tuesday as a fall in U.S. Treasury yields encouraged further selling of the dollar, with the yen and trade-linked currencies such as the Chinese yuan also racking up strong gains.

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 building on Monday’s gains.

The dollar, measured against a basket of currencies, fell to its weakest since November 22.

U.S. Treasury yields fell overnight, with two-year yields rising above those of longer-dated 5-year notes for the first time in more than a decade.

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.

Continuing interest rate hikes have sent short-dated yields higher while tepid inflation and slowing economic growth expectations have kept longer-dated yields pinned down.

“Clearly investors think the Federal 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 0.6 percent to 96.473, while the euro added as much as half a percent to $1.1419.

Reichelt said that despite the headwinds for the dollar, without a resolution on the European Union’s dispute with Italy over its proposed budget, 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 half a percent against the offshore yuan to 6.8421 on Tuesday, its weakest level since September. On Monday, the dollar shed more than 1 percent versus the yuan, its steepest fall since Aug. 25.

YUAN STRENGTH

Analysts said that investors were nervous about the trade war truce, with only vague statements from both U.S. President Donald Trump and Chinese leader Xi Jinping. The edgy mood was evident in weakness in stock markets on Tuesday.

“On the other hand, it hasn’t prevented the Chinese yuan from making further gains overnight and...the yuan is as much a leader as a follower of global FX mood,” said Kit Juckes, FX strategist at Societe Generale.

The Australian dollar, generally sensitive to global risk sentiment, was also further boosted by the broad-based dollar selling, gaining 0.4 percent in Asian trade to $0.7384. The Reserve Bank of Australia kept its policy cash rate unchanged on Tuesday in a widely expected move.

The yen gained 0.8 percent to 112.74 yen per dollar and was on course for its biggest one-day rise since July.

Emerging market currencies including the Mexican peso and Indian rupee were mostly up against the dollar on continued relief over Washington and Beijing’s trade war ceasefire. (Editing by Andrew Heavens;Editing by Kirsten Donovan)

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