The dollar rose on Tuesday as investors further unwound bearish bets against it following a bounce in Treasury yields and ahead of US inflation data flagged as the next risk event for the market. "The US inflation data is a big risk for the markets and given the extreme short dollar positioning in the market, the greenback may jump higher if inflation surprises on the upside," said Caxton FX analyst Alexandra Russell-Oliver.

Short dollar bets were the third most crowded trade in global markets in the first week of September, according to a Bank of America Merrill Lynch investor survey. Positioning against the dollar has ballooned to record levels in recent months as soft economic data and an impending change of guard at the Federal Reserve has made markets extend bets that US interest rates are unlikely to go up any time soon.

"Nothing fundamental has changed about the outlook for the dollar, namely that the market has become more sceptical about the Fed's intention to raise rates in the near term and Thursday's inflation data may bolster those bets," said Antje Praefcke, an FX strategist at Commerzbank AG in Frankfurt. The dollar index, which tracks the currency against a basket of six major rivals, rose 0.1 percent at 91.966, after it skidded to a 2-1/2-year low of 91.011 on Friday.

The index posted its second-biggest daily rise this year on Monday as 10-year US Treasury yields rose 8 basis points to 2.125 percent. Yields extended gains on Tuesday. Despite the dollar bounce, net short bets against the currency remain near their highest levels since January 2013 as expectations of Fed tightening have faded. Currency markets now anticipate only one US rate increase by the end of 2018, compared with expectations a few weeks ago of a hike before the end of this year.

Morgan Stanley's position tracker shows only 7 percent of traders are bullish about the dollar outlook. US inflation data due on Thursday is unlikely to show a significant pick-up in price pressures, with the August reading forecast at 1.6 percent on an annual basis versus 1.7 percent in July. The Fed has a 2 percent inflation target. The dollar was steady at 109.57 yen after rallying 1.4 percent on Monday, its biggest one-day surge since mid-January. It had slumped to a 10-month low of 107.320 yen on Friday, when Hurricane Irma threatened Florida and as financial markets braced for the possibility of another missile or nuclear test to mark North Korea's founding day on September 9. The euro edged higher against the dollar at $1.1940 in early trades.

Copyright Reuters, 2017