NEW YORK (MarketWatch) -- The U.S. dollar fell against most other major currencies Tuesday, but gained slightly against the Japanese yen, as risk appetite rebounded and U.S. stocks posted strong gains.
The dollar index , which tracks the performance of the dollar against a trade-weighted basket of six major currencies, was at 86.555, down from 86.991 in late North American trading Monday.
On Wall Street, U.S. stocks ended higher, a day after the Dow Jones Industrial Average recorded its fourth-biggest point drop on record. See Market Snapshot. The euro rose to $1.2710 from $1.2610 late Monday.
"Euro/dollar rallied from a low of $1.2563 during early European trading to a high of $1.2766 as investors tentatively returned to buy riskier assets after Monday's bout of risk aversion," said Matthew Strauss, senior currency strategist at RBC Capital Markets in a note to clients Tuesday.
But the dollar gained slightly on its Japanese counterpart, trading at 93.14 yen, up from 93.05 yen late Monday.
The greenback surged Monday against all major currencies except the yen as stock markets around the world plunged and investors liquidated assets. The Japanese unit has been the top beneficiary of rising risk aversion as investors flee or shun carry trades.
Carry trades center on borrowing in low-yielding currencies such as the yen and then buying assets denominated in higher-yielding currencies -- a strategy that once served to keep the yen under pressure.
A decision by the Bank of Japan's policy board in an unscheduled meeting Tuesday to accept a broader range of collateral during liquidity operations had little direct currency market impact, strategists said. See full story.
Central bank meetings ahead
The British pound bought $1.4916, up from $1.4883 late Monday. The pound on Monday posted its largest one-day drop against the dollar since 1992, just after the pound's ejection from the European exchange-rate mechanism.
Despite Tuesday's lost ground, the dollar is likely to remain well-supported against the euro and the pound as policy meetings for the European Central Bank and the Bank of England on Thursday approach, said strategists at UniCredit MIB in Milan.
Both central banks are expected to aggressively cut interest rates as inflation pressures fade sharply and deflation worries move to the fore.
"While sterling has already incorporated a new BOE easing to 2% on Thursday, a mere 50 basis point cut by the ECB, as we expect, should drag the euro further lower," the UniCredit strategists said.
Already widely-held expectations for aggressive rate cuts by the BOE and the Frankfurt-based ECB were strengthened Monday by steep falls in closely watched purchasing managers' indexes for the manufacturing sector. See full story.
The BOE's rate-setting Monetary Policy Committee last month slashed the central bank's key lending rate by 1.5 percentage points to 3% -- its lowest level in more than 50 years. Another aggressive cut is expected Thursday.
And credit markets anticipate the ECB, which trimmed its key rate to 3.25% from 3.75% at its November meeting, will cut by another 75 basis points Thursday, according to Giuseppe Maraffino, an economist at UniCredit.
The Australian dollar was higher vs. the dollar after the Reserve Bank of Australia met market expectations for a 100 basis point cut in its key lending rate to 4.25%.
The Australian dollar rose 0.4% against the greenback to 64.25 U.S. cents.
