The US dollar weakened on Friday, pressured by lackluster employment data that dampened expectations for a near-term interest rate hike by the Federal Reserve. The Bloomberg Dollar Spot Index fell as much as 0.5%, touching its lowest level since May. The greenback declined against all major currencies, with the Japanese yen posting significant gains. July's non-farm payrolls unexpectedly contracted, defying market forecasts, while job creation figures for the prior two months were also revised downward.

"Today's US data significantly eroded confidence in a September rate hike from the Fed," said Sarah Ying, Head of FX Strategy at CIBC Capital Markets. "We anticipate the US economic data will cool, ultimately leading the Fed to hold rates steady." The dollar has broadly weakened since late June as markets gradually reduce expectations for a hawkish Fed stance aimed at curbing inflation. The cost of hedging against a rise in the dollar over the next six months, relative to the cost of hedging against a decline, has dropped to its lowest since mid-May, signaling waning bullish sentiment on the currency.

The Commodity Futures Trading Commission (CFTC) is scheduled to release updated data on trader dollar positioning later Friday. According to data through July 28, traders had increased their bullish bets on the dollar, with bullish sentiment reaching its highest level since 2014. Interest rate swaps now indicate traders see roughly a 40% probability of a Fed rate hike next month, down from nearly 60% before the jobs report. With Fed Chair Kevin Warsh choosing not to provide guidance on the central bank's future policy path, each economic data release becomes increasingly critical, potentially triggering a recalibration of rate hike bets and fueling market volatility. Before the Fed's September policy meeting, one more employment report and two inflation readings are due.

"This report reinforces our long-held view that the market has overestimated the likelihood of Fed rate hikes," said Nathan Thooft, Senior Portfolio Manager at Manulife Investment Management. "Further weakness in employment would give the Fed ample reason to maintain its current stance."