The yen strengthened on Tuesday as softer equity markets ahead of a flurry of U.S. data signaled a return to risk aversion for nervous markets, leading investors to unwind carry trade positions.

The high yielding New Zealand dollar lost ground as investors moved out of the carry trade where they borrow low yielding currencies to fund purchases of higher return assets.

U.S. stock futures pointed to a weak start on Wall Street after a three-day weekend as investors remained wary about the health of the U.S. economy following recent turbulence caused by problems in the housing market.

Since the opening of the European session we've seen a slight rebound in risk aversion. European equity markets are slightly negative and the yen is positive. Essentially we are waiting for the opening of the U.S. session today, said Carole Laulhere, currency strategist at Societe Generale in Paris.

Traders said the market remained wary of taking risky positions before reports on U.S. factory activity later in the day, a monthly payrolls report on Friday and central bank interest rate decisions later this week.

By 5:42 a.m. EDT, the euro was down 0.3 percent versus the yen at 157.02. The dollar had lost 0.5 percent to 115.47 yen. The euro was down 0.1 percent at $1.3602.

The New Zealand dollar had fallen half a percent against the greenback and 0.8 percent versus the yen.

The U.S. Institute for Supply Management's index on manufacturing is seen slipping to 53.0 in August from 53.8 the previous month, staying well above the 50 mark between growth and contraction.

The downside drift might have more impact on the USD in a negative way, as strong data might be viewed skeptically under the current uncertainty, Citigroup said in a research note.

RATE DECISIONS IN FOCUS

The high-yielding Australian dollar held up well in the face of heightened risk aversion, supported by surprisingly strong second quarter growth data which has boosted the case for further rate hikes from the current 6.50 percent.

This week though, markets and analysts alike expect the Reserve Bank of Australia to keep rates unchanged.

For the European Central Bank, the latest Reuters poll gave a median 40 percent chance of a rate hike on Thursday.

The ECB last raised rates in June, to 4.0 from 3.75 percent, and was widely expected to tighten policy again this month until the flare-up of market volatility.

The Bank of Japan is also seen keeping interest rates on hold at 0.5 percent in the coming months, especially after a surprise decline in capital spending in the second quarter which could result in an economic contraction for the April-June period.

In the United States, the recent market turmoil has prompted markets to price in a Fed rate cut of at least 25 basis point on September 18 from the current 5.25 percent.

Citigroup Investment