The growing market consensus is that the Fed will tolerate what it sees as a temporary acceleration in inflation, which will keep the dollar lower against most major currencies.
"The dollar is on its knees and this seems to be a direct result of how investors feel about the U.S. inflation outlook and the Fed's reaction," said Valentin Marinov, head of G10 FX research at Credit Agricole.
Marinov highlighted two inflation outlook scenarios that would have different impacts on the markets - the first one being the current market expectation that price growth will soon ease.
"This will keep the Fed dovish, U.S. real yields very negative and the dollar weak ... boosting commodity prices and supporting risk assets," he said. "Under the second inflation outcome, we see a more persistent rebound of the U.S. inflation this and, potentially, early next year."
Under Marinov's central scenario, that could nudge the Fed towards tapering bond purchases this summer, thus boosting the outlook for U.S. Treasury yields and the dollar.
The benchmark 10-year U.S. Treasury yield stood at 1.6471%, extending a pullback from a five-week high reached last week.
The dollar traded above $1.22 to the euro, the single currency hitting its highest against the greenback since Feb. 25. The British pound rose past $1.42 for the first time since Feb. 24. Sterling has been buoyed as investors cheer the gradual lifting of strict coronavirus restrictions.
The Canadian dollar advanced to a six-year high of 1.2013 to the greenback, aided by a rise in oil prices. Up 5% against its U.S. peer year-to-date, the trader-nicknamed "loonie" is the best performing G10 currency on the year.
The dollar lost 0.3% to 108.96 yen JPY=D3 . The Japanese currency is the worst-performing G10 currency this year, down over 5% year-to-date against the greenback amid worries about Japan's slow pace of vaccinations and weakness in the greenback.
Some investors were already scaling back expectations for a Fed rate hike this year, and Kaplan's comments gave traders even more incentive to sell the dollar.
The onshore yuan edged up to 6.4188 per dollar, not far from an almost three-year high reached last week.
The Australian and New Zealand dollars rose as much as half a percent each against their U.S. counterpart.
In the cryptocurrency market, bitcoin rose 3.3% to $45,023.53 but was still close to a three-month low after Tesla boss Elon Musk dented enthusiasm for the digital asset.
Rival digital currency ether rose 6.50% to $3,494, steading from a two-week low on Monday.
(Reporting by Ritvik Carvalho, Additional reporting by Stanley White in Tokyo, Editing by Gabriela Baczynska and Steve Orlofsky) ((Ritvik.Carvalho@thomsonreuters.com; +44 2075429406; Reuters Messaging: firstname.lastname@example.org; Twitter @ritvikcarvalho))