WASHINGTON, DC - MAY 20: Newly redesigned $100 notes lay in stacks at the Bureau of Engraving and Printing on May 20, 2013 in Washington, DC. The one hundred dollar bills will be released this fall and has new security features, such as a duplicating portrait of Benjamin Franklin and microprinting added to make the bill more difficult to counterfeit. Mark Wilson/Getty Images/AFP

WASHINGTON – The US dollar extended gains in early afternoon trading as Federal Reserve Chair Janet Yellen said central bankers should be wary of raising rates too gradually.

Yet the move proved fleeting as she said policy makers may have misjudged the strength of the labour market and forces behind inflation, prompting traders to unwind greenback purchases as a more neutral interpretation of her remarks prevailed.

Yellen said it was “imprudent to keep monetary policy on hold until inflation is back to 2 per cent.” The Bloomberg Dollar Spot index rose as much as 0.6 per cent to its highest in more than a month, before giving back about half its gains. The euro hovered around 1.1800 versus the dollar, while Canada’s loonie rallied after Finance Minister Bill Morneau gave an upbeat assessment of the economy.

The odds of another quarter-point rate increase by year-end stand at about 65 per cent, using the current effective fed funds rate and the forward overnight index swap rate. The probability was as low as 22 per cent on Sept 8.

Yellen also said that downward pressures on inflation “could prove to be unexpectedly persistent” and that under certain conditions, “continuing to revise our assessments in response to incoming data would naturally result in a policy path that is somewhat easier than that now anticipated.”

Earlier, Atlanta Fed President Raphael Bostic said he’s “pretty comfortable” with a December rate hike; Fed Governor Lael Brainard spoke on labour market disparities, but didn’t comment on the future path of monetary policy EUR/USD was just shy of 1.1800.

The pair earlier traded down to 1.1758, the lowest in more than a month, as US traders sold early, joining model-driven accounts and others who had unwound longs overnight, according to traders familiar with the transactions who asked not to be identified because they are not authorised to speak publicly.

Some traders are now eyeing technical targets near 1.1700 or the August low at 1.1662. Markets are continuing to digest the weekend’s election that left Chancellor Merkel with the task of forming a coalition that will have broader implications for German and European economic policies and possibly impact ECB monetary policy.

That outcome has cast a cloud over the shared currency as traders weigh the potential effect just as the central bank is trying to carefully shift to a less-accommodative stance.

USD/JPY was trading around 112.30 after rising to a session high of 112.48. Market jitters over North Korea subsided and the 10Y Treasury yield rose to a new high for the day, fuelled in part by hedging tied to a Saudi Arabia bond issue.

USD/JPY may be anchored near 112.00 over coming sessions as a large 112.00 expiry rolls off today. For all the volatility, USD/JPY remains trapped in Monday’s 111.48/112.53 range.

CAD rose to a fresh high for the day at 1.2331 after Finance Minister Morneau said he expects further rate hikes from the Bank of Canada. BOC Governor Poloz speaks today, text available on BOC website at 11.45am ET, and traders will parse remarks for guidance on path of future rate hikes following rate increases in July and September.

— Bloomberg