Oct 22 (Reuters) - The U.S. dollar was just off a 2-1/2 month high on Tuesday on expectations the Federal Reserve will take a measured approach in easing its policy, while a too-close-to-call U.S. election campaign kept investors on edge.
The dollar's strength, boosted by rising Treasury yields, kept pressure on the yen, euro and sterling, a theme that has been building over the past few weeks as traders scale back their bets on rapid U.S. rate cuts.
Benchmark 10-year Treasury yields rose 3 bps in London trade to a fresh 12-week high as investors priced for a more robust American economy.
Some analysts argued that the release of the Beige Book late on Wednesday could be the biggest threat to the greenback this week, with the previous summary of economic conditions regarded by some as the main trigger for the 50-basis-point-(bp)-rate cut in September that kicked off the Fed's easing cycle.
Markets are pricing in an 87% chance of the Fed cutting rates by 25 bps next month, versus a 50% chance a month earlier, when investors saw an equal likelihood of a larger 50-bp cut, the CME FedWatch tool showed.
Traders are anticipating another 40 bps of easing overall for the rest of the year .
"The U.S. dollar rose recently on the hawkish repricing of expectations for the Fed monetary policy and because uncertainty regarding U.S. elections reduced risk appetite supporting safe-havens," said Nick Andrews, strategist at HSBC.
However, U.S. elections are still the main focus.
Markets expect the strongest dollar response from a Republican sweep, which should open the door to larger increases in trade tariffs in combination with fiscal stimulus.
A smaller rally for the greenback is seen in response to a divided Republican government outcome, while a Democratic sweep or a divided Democratic government would likely result in some initial downside.
The dollar index , which measures the U.S. currency versus six others, was last at 103.91, having touched 104.02 on Monday, its highest since Aug. 1. The index is up more than 3% so far this month.
The euro last bought $1.0827, near its lowest since Aug. 2, while sterling was at $1.3006, near its lowest since Aug. 20.
Euro zone PMI data on Thursday could provide an additional downward push to the single currency if it underlines the poor economic situation in the euro area and boosts bets on future European Central Bank rate cuts.
ECB speakers will also be in focus after President Christine Lagarde delivered a dovish message last week.
"The key question is: are the hawks fine with Lagarde’s sanguine disinflation view, a gradual shift in focus to growth and such a dovish market pricing?" said Francesco Pesole, forex strategist at ING.
"Given some lingering pockets of sticky services inflation in the euro zone, the answer is probably no."
ELECTION IN FOCUSWith the U.S. election just two weeks away, the rising odds of former President Donald Trump winning are boosting the dollar, since his proposed tariff and tax policies are seen as likely to keep U.S. interest rates high.
"Even small changes in tight polls could drive seemingly erratic swings in market sentiment," said Antti Ilvonen, forex analyst at Danske Bank.
The yield on the benchmark U.S. 10-year Treasury note rose to its highest since July 26 at 4.22%.
That weighed on the yen , which was roughly unchanged at 150.88, after touching a near three-month low of 151.10 per dollar.
The Bank of Japan is carefully looking at the upside risks from rising import prices as the yen weakens, Executive Director Takeshi Kato was quoted as saying by Jiji Press on Tuesday.
The yen weakness comes with Japan set to conduct a general election on Oct. 27. While opinion polls vary on how many seats the ruling Liberal Democratic Party will win, markets have been optimistic that the LDP, along with junior coalition partner Komeito, will prevail.
Barclays expects a suppression of pricing of BoJ rate hikes and an increase in fiscal concerns, driving the yen higher if the LDP/Komeito coalition has to form a government with additional coalition partners.
It also forecasts that in the unlikely event (tail risk scenario) of the LDP and its coalition partner Komeito being unable to form a government, risk-off moves could drive a sudden 2% drop in the dollar/yen exchange rate.
Reporting by Stefano Rebaudo; Editing by Muralikumar Anantharaman, Christian Schmollinger, Kirsten Donovan and Mark Heinrich
