The US dollar has suffered its biggest decline since May, as the unexpected weakness in the US employment report has heightened market concerns about the economic outlook, leading traders to bet that the Federal Reserve will cut interest rates more this year.

Bloomberg's US Dollar Spot Index fell 0.7 percent on Friday as the prospect of a softer US monetary policy and a sharp drop in US government bond yields weakened the dollar's attractiveness. The yen posted the biggest decline against major currencies, seeing its strongest week since 2022 after the Bank of Japan raised interest rates.

The dollar's decline highlights that investors are focused on the relative path of global central banks, rather than potential demand for the dollar as a safe haven, as concerns about the economy intensify. The stock market also fell due to labor market data, as did oil prices - a backdrop of turmoil that could support the euro.

Valentin Marinov, Head of FX Strategy at Credit Agricole CIB, said: "As US rates markets continue to digest the Fed's aggressive easing policies, the dollar is indeed in a precarious position." "This is eroding the dollar's rate advantage, pushing down the dollar against other G10 currencies."

Although the US dollar has been boosted for much of this year by the Federal Reserve maintaining its benchmark interest rate at its highest level in over two decades, while the economy remained resilient, Friday's decline reduced Bloomberg's US Dollar Spot Index's gain for the year to 3%, still slightly above its 200-day moving average.

In 2024, the only currency in the G10 that appreciated against the dollar was the pound, while commodity currencies and the yen fell behind. The yen against the US dollar is still down nearly 4% this year. The currencies of commodity-exporting countries - Australia, Canada, New Zealand, and Norway - have performed worse, falling between 4% and 7%.

Bullish

For those who are bullish on the dollar, if deteriorating market sentiment leads to an increased demand for the global major reserve currency as a safe haven, market volatility and concerns about the economy may reverse the trend of the dollar.

Adam Farstrup, Head of Multi-Asset Americas at Schroders, said: "If we enter into a US-led global recession, we typically see the dollar initially weaken and then strengthen."

While a US economic recession is not his base-case scenario, he said the likelihood had increased slightly after Friday's data release.

If the Federal Reserve does not ease monetary policy to the extent that investors and economists currently expect, this would be another potential aid to the dollar. Futures traders on Friday expected the Fed to cut interest rates by a full percentage point by year-end - and the Fed only has three meetings left in 2024.

Kathleen Brooks, Head of Research at XTB, said: "All the factors stemming from the bond market are driving the FX market." "Between now and January, will the market be disappointed with the Fed? This will boost the dollar."

In recent weeks, bullish sentiment for the dollar has waned, while market expectations that the Federal Reserve will follow the Bank of Canada, European Central Bank, and Bank of England in lowering borrowing costs have continued to rise.

According to data from the Commodity Futures Trading Commission as of the week ended July 30, hedge funds, asset managers, and other speculative market participants currently hold about $15 billion in bullish bets on the dollar. Although this position increased from the previous week, it is still down over 50% from the approximately $33 billion in April.

Sophia Drossos, a strategist at Point72 Asset Management, said: "The slowdown in economic data that we're seeing challenges the exceptionalism view of the United States, and this should be consistent with a reversal in the dollar's rise against other currencies."