The British pound posted the worst performance as UK markets faced fresh selling pressure amid escalating fiscal concerns. All Group of Ten (G-10) currencies declined against the US dollar, with the yen underperforming most other currencies following reports that a key ally of Japan's Prime Minister intends to resign.

The Bloomberg Dollar Index advanced 0.5%, reaching an intraday high of 0.8%. US Treasuries were sold off following sharp declines in European long-term bonds.

US factory activity contracted for the sixth consecutive month in August, with production declining as manufacturing continues to face headwinds from higher import tariffs.

"The August ISM manufacturing data reinforces the case for a 25 basis point cut in the federal funds rate in September," said Elias Haddad, strategist at Brown Brothers Harriman. "Friday's August nonfarm payrolls report will determine whether markets begin betting on a 50 basis point cut at the September 16-17 FOMC meeting or maintain current expectations for 25 basis points."

"Rising UK gilt yields continue to pressure the pound," noted Brad Bechtel, Global Head of FX at Jefferies. He added that "French politics remain in limbo, as does Japan's political situation," affecting their respective currencies and thereby boosting the dollar index.

GBP/USD fell 1.1% to 1.3393, marking its lowest level since August 22.

The pound's sensitivity to rising long-term yields remains higher than most major currencies.

USD/JPY climbed 0.8% to 148.38. The yen initially came under pressure after Bank of Japan Deputy Governor Ryozo Himino's Tuesday remarks lacked hawkish undertones.

The yen extended its decline following reports that Hiroshi Moriyama, Secretary-General of Japan's ruling Liberal Democratic Party, intends to resign.

Political risks weigh on the yen as investors reduce bets on Bank of Japan rate hikes this year.

EUR/USD dropped 0.6% to 1.1641.

USD/CAD rose 0.2% to 1.3783, with the Canadian dollar outperforming other G-10 currencies on Tuesday.