Bolstered by persistently high inflation, a robust jobs market and dwindling odds that the Federal Reserve will slash interest rates, the US dollar cooled off in May as cracks emerged throughout the domestic economy.

The US dollar index, which measures the dollar against a basket of foreign currencies, hit its highest point in nearly five months in late April before falling throughout much of May. The decline came after the government's latest employment report showed that job growth almost halved from March to April and wage growth decelerated to its slowest speed in nearly three years.

With inflation and other reports showing more signs of cooling, Fed watchers who felt the central bank may not cut rates at all in 2024 are now anticipating as many as three cuts before the end of the year.

"Since the start of the year the market has progressively pushed back its expectation of when the first Fed rate cut of the cycle will come," said Jane Foley, head of foreign exchange strategy at Rabobank. "Now that the market is positioning long [US dollars], however, it is more sensitive to the suggestion from some US economic releases that the US economy is slowing and that the Fed will be able to cut rates at some point in the months ahead."

The dollar tends to rise with interest rates and tighter monetary conditions as investors move to government bonds and other dollar-denominated securities. A stronger dollar bolsters US spending power abroad but can dent overseas profits for US-based companies.

Since the end of 2023, the dollar has outpaced all its currency peers in the Group of 10 major economies, known as the G10, except the British pound, which remains slightly higher. In May, however, the dollar lost ground to all of those other currencies, particularly the Norwegian krone, the Swedish krona and the New Zealand dollar.

Some of this strength in foreign currencies has been due to the shift in monetary policy timing expectations, as rate cuts are likely to begin later than initially anticipated in the UK, New Zealand, Australia and Norway, Foley said. But expectations for cuts are not the only driver as these G10 peers surge above the dollar.

"Rate spreads have been an important driver of [foreign exchange] rates this year," said Chris Turner, head of foreign exchange strategy at ING. "However, other factors have been at play, too."

These other factors include low foreign exchange volatility, which has favored the carry trade, and increasingly unstable geopolitics and higher oil prices, which can boost currencies in energy-producing countries over those of importing countries, Turner said.

For now, the correlation between the dollar and interest rate expectations has fallen significantly in May, said Matthew Weller, global head of market research with Forex.com and City Index.

Instead, the dollar has been weighed down by the "slow, but solid" economic recovery in other major economies, including the UK, Weller said.

"At this point, the market is already looking ahead to the final third of the year when the Fed is likely to start its interest rate cutting cycle and other major central banks are expected to be solidly in the middle of a sustained rate reduction cycle," Weller said.

"If the economic data allows the Fed to resist this anticipated broad easing cycle, the US dollar is likely to be a big beneficiary in the second half of the year."