* Markets continue to take profit from Dec's long dlrs
* Dollar drops 1 percent against the yen
* U.S. payrolls awaited to gauge dollar direction (Recasts, updates prices, adds quote, changes byline, dateline; previous LONDON)
By Gertrude Chavez-Dreyfuss
NEW YORK, Jan 5 (Reuters) - The dollar fell against the yen on Tuesday as investors pared back December's bullish bets on the greenback ahead of the U.S. non-farm payrolls report later in the week.
The U.S. currency reversed last week's gains, unable to take advantage of strong U.S. manufacturing data on Monday. Some analysts said investors capitalized on the robust U.S. data to buy into riskier assets, using the dollar to finance these trades.
But others said trades were based on position adjustments and profit-taking after the dollar posted strong gains in December.
"The fact of the matter is that investors have been very short most of the major currencies except the dollar, and I think they're buying them back ahead of the the key event risk, which is the non-farm payrolls report," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York.
Data from the Commodity Futures Trading Commission released on Monday showed an increase in long-dollar positions for a second straight week to Dec. 29. For the fourth week running, the non-commercial position was short euros.
"There's also some thought that the dollar's year-end move was too far, too fast, so people are booking some profits. There's not a lot of conviction in those long dollars." said Chandler.
Still, analysts said risk appetite remains a driver in the currency market and should not be totally disregarded. The theme, however, stayed in the background in December as investors priced in the onset of higher U.S. interest rates in mid-2010 amid upbeat economic data.
In early New York trading, the euro was little changed at $1.4395, having climbed to around $1.4483 earlier in the day to hit its strongest in nearly three weeks.
The dollar fell about 1 percent to 91.60 yen, on track for its biggest one-day percentage loss in nearly a month.
The latest CFTC data showed that large speculators have flipped to long dollars versus the yen last week for the first time since June, leaving the currency pair vulnerable to a modest correction.
"Alongside the shift in positioning ... the currency pair (dollar/yen) had rallied nearly 10 percent off the late-November lows, and that in itself increased the risk of some back-filling in the short-term," said HSBC in a research note.
The ICE Futures' dollar index, which tracks its performance against a basket of six major currencies, slipped 0.05 percent.
Analysts are awaiting the U.S. payrolls figure, which would help determine the dollar's near-term direction. The median forecast of analysts polled by Reuters is for a decline of 8,000.
The euro was 0.2 percent higher versus the Swiss franc at 1.4861 francs after hitting a 10-month low of 1.4834 on Monday.
Many in the market say that the 1.48 level in the euro/Swiss franc pair is crucial because the Swiss National Bank may step in to stem further strength.
A fall below that level triggered the Swiss central bank's foray into the currency market in March 2009, and it has been selling francs sporadically since then.