The dollar struck a 1-1/2-month high on Tuesday as Treasury yields rose after a strong reading for US manufacturing activity hardened expectations for US interest rates to rise by the year-end.

The Australian dollar slipped to its lowest in more than two months after the Reserve Bank of Australia left interest rates unchanged and gave a somewhat cautious assessment of the local economy.

The dollar index against a basket of six major currencies was up 0.3 per cent at 93.848 after touching 93.891, its highest since August 17.

US Treasury yield

On track for its third straight day of rises, the benchmark 10-year Treasury yield edged up to 2.351 per cent after briefly touching a three-month high of 2.371 per cent overnight.

Debt yields and equities rose - Wall Street shares reached record highs - after a measure of US manufacturing activity for September released on Monday showed a surge to a 13-1/2-year high.

“The dollar is drawing support from familiar themes. The Fed continues to sound hawkish, US indicators are good and price indicators are rising,” said Bart Wakabayashi, Tokyo Branch Manager of State Street Bank.

“All these factors are cementing the prospect of a December rate hike by the Fed.”

The euro was down 0.2 per cent at $1.1708 after brushing $1.1702, its weakest since August 17. The common currency had already slid 0.7 per cent overnight against a data-boosted dollar.

Catalonia referendum

The euro also took a knock on Monday as Spain faced its biggest constitutional crisis in decades after Sunday's independence referendum in Catalonia.

“The impact on the euro from the Catalonia vote is likely to fade. Other euro zone markets, like those in Germany, have taken the vote in their stride. Wanting independence and actually achieving it are also two different matters,” said Yukio Ishizuki, senior currency strategist at Daiwa Securities.

The dollar, which initially fell to 112.660 yen early in the session, was up 0.35 per cent at 113.150 yen. A rise above 113.260 would take the greenback to its highest since mid-July.

Still, some saw the dollar facing turbulence against the yen in the coming sessions as traders considered the implications of Japan's snap general election later in the month.

Dollar/yen risk reversals

Ishizuki at Daiwa Securities pointed out that one-month dollar/yen risk reversals showed dollar puts are more popular.

“What this means is that participants, particularly foreigners, are wary of the upcoming elections and its possible negative impact on Abenomics,” Ishizuki said.

Market participants try to hedge against currency risk and volatility through the use of risk reversals, in which “puts" give them the option to sell.

Japan snap election

Japanese Prime Minister Shinzo Abe had last week dissolved the parliament's lower house and called a snap election for October 22.

Abe's ruling Liberal Democratic Party (LDP) was initially expected to win the election with relative ease. An easy win, however, is looking less assured with popular Tokyo governor Yuriko Koike forging an alliance of opposition parties to challenge the LDP.

The Australian dollar fell 0.4 per cent to $0.7792, its lowest since July 18, after the RBA's policy decision on Tuesday.

RBA policy stance

The RBA kept interest rates on hold at a record low of 1.5 percent as widely expected while noting that a stronger local currency would slow the economy and restrain price pressures.

The central bank said local economic growth was expected to pick up gradually in the coming years. But it also noted that slow wage growth and high household debt are likely to constrain spending and growth.

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