By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) - The safe-haven Japanese yen and Swiss franc pulled back from recent highs against the dollar on Tuesday as financial markets stabilized, with investors turning more hopeful that U.S.-Iran tensions would not escalate into an all-out war.
Better-than-expected U.S. non-manufacturing sector and factory orders data also lifted the dollar.
The yen fell from a three-month high versus the dollar, although sentiment remains fragile amid nagging worries about the impact of the deterioration in U.S.-Iran relations.
A U.S. drone strike in Baghdad on Friday killed Iranian military commander Qassem Soleimani, widely seen as Iran's second-most powerful figure.
(Graphic: U.S. dollar vs Japanese yen click, https://fingfx.thomsonreuters.com/gfx/mkt/13/653/653/yen%20jan%207.png)
The Swiss franc, another safe haven, fell from four-month highs against the euro and dropped versus the dollar.
"The big risk-off trade of last week has begun to fade and we're seeing increased appetite across the spectrum," said Karl Schamotta, chief market strategist at Cambridge Global Payments in Toronto.
"You're looking at traders taking a more nuanced view of the strategic calculus between the U.S. and Iran, and downgrading the likelihood of an escalatory cycle that damages the global economy," he added.
U.S. Secretary of Defense Mark Esper said on Tuesday Washington is seeking a diplomatic solution with Iran but that Tehran needs to de-escalate. He added that Soleimani planned to execute an attack on U.S. assets or interests days before he was killed.
In afternoon trading, the dollar was up 0.1% against the yen at 108.53 yen
The Swiss franc also weakened, with the dollar up 0.3% at 0.9710 franc
The dollar index, which fell on Monday, gained 0.4% to 97.01 <.DXY>, as the euro fell 0.4% to $1.1144
The dollar got a boost after data showed the Institute for Supply Management's non-manufacturing index at 55 in December, up from 53.9 in November and slightly higher than market expectations.
U.S. factory orders, however, fell 0.7% in November, though that was a little better than forecasts of a 0.8% drop..
That said, the dollar's performance has been mixed in recent sessions, with the slightly better-than-expected euro zone business survey data on Monday supporting the euro.
The euro was little moved by data showing euro zone inflation accelerated in December and retail sales were stronger than expected. Recent survey data has pointed to improving investor and business confidence in the euro zone.
Elsewhere, the onshore yuan
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Dan Grebler and Richard Chang)