Dollar stifled by weak labor force participation

U.S. dollar bills are laid out for a photo.
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A softer labor force participation rate – one of several negative stand-outs tainting last Friday's otherwise strong U.S. jobs report – will blunt gains in the dollar this week, CNBC's latest market survey of currency traders, analysts and strategists showed.

Although more than half of CNBC poll respondents (55 percent) believe the forecast-busting 288,000 payrolls gain will be positive for the U.S. dollar, advances will be capped by the weaker components within the April jobs report, signaling a still sluggish labor market.

"Don't expect a major dollar recovery this week," said Kathy Lien, managing director of FX Strategy for BK Asset Management. "Due to the drop in the labor force participation rate and zero wage growth, the NFP report won't change the Fed's stance on monetary policy."

Federal Reserve Chair Janet Yellen, scheduled to speak this Wednesday on the economic outlook before the Joint Economic Committee in Washington and on the following day before the Senate Budget Committee, "will remind us that tapering does not equal tightening which will put pressure on (U.S. bond) yields and in turn, the dollar," Lien said.

Read More Payrolls jump in April as thaw hits jobs market

Nearly a third of the market professionals surveyed by CNBC (34 percent) believe the greenback will decline while 11 percent say the dollar will trade at around current levels.

Friday's jobs report triggered a choppy reaction in the dollar. The dollar index, which tracks the greenback against a basket of six major currencies, initially rallied to a high of 79.852, only to then slide to a session low of 79.469.

Deep dig into labor participation numbers

Reports of violence spreading to the Black Sea port city of Odessa in Ukraine undermined the dollar further against the safe-haven Japanese yen.

"[The dollar] did very well then it all turned to custard," said Peter Redward of independent research firm Redward Associates Ltd. "I'm not sure it's the participation rate per see but more a view that the Yellen Fed is uber-dovish. Then the news on Ukraine hit and everyone ran for cover."

Many currency market professionals believe that the U.S. dollar won't stage a meaningful rally until yields on longer-dated U.S. Treasuries start recovering from multi-month lows.

U.S. yields

A lack of inflation and the simmering conflict in Ukraine has helped longer-dated Treasuries rally hard in recent weeks with yields on 30-year paper slumping to 10-month lows on Friday. Bond markets perceive a weaker inflation outlook is giving the Federal Reserve a reason to keep rates near-zero for longer.

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"Without fear on a quicker turnaround from the Fed, it is not clear that we will see sufficient rises in U.S. yields to lend the dollar broad support," said Todd Elmer, head of G-10 foreign-exchange strategy for Asia ex-Japan at Citigroup.

Nevertheless, dollar bulls UBS maintained their view in stark contrast with current price action in currency and U.S. Treasury markets.

"In the very near term lower yields and a softening greenback are the markets' clear pain trades," wrote Mansoor Mohi-uddin, head of foreign exchange strategy at UBS in FX comments emailed to CNBC on Saturday.

"But the fundamental picture is improving for the greenback as the Fed's balance sheet expansion should finish within the next few months and the U.S. economy is picking up momentum following a very weak Q1 2014. Our underlying view therefore remains to favor the dollar on dips rather selling the currency on rallies," Mohi-uddin added.

Data on Friday showed U.S. employers hired workers at the fastest clip in more than two years in April, pointing to a rebound in economic growth after a severe winter.

But the brightening outlook was tempered by a sharp increase in the number of people dropping out of the labor force, which pushed the unemployment rate to a 5-1/2-year low of 6.3 percent, Reuters reported.

Read More Long-dated Treasurys rally after crucial jobs data

The labor force participation rate - or the share of working-age Americans who are employed or unemployed but looking for a job - also fell four-tenths of a percentage point to 62.8 percent last month, slipping back to a 36-year low touched in December. Wage growth also was stagnant.

Commenting ahead of Friday's jobs numbers, David Forrester, Senior Vice President, G10 FX Strategy at Macquarie, said "measures of labor market slack" such as hours worked, private-sector wages and the U6 unemployment rate will be closely-watched by Fed policymakers.

"For there to be a large move (in U.S. dollar), you would have to also see declines in people working part-time, but wanting full-time work and marginally attached workers – those outside the labor force, but who want a job," he added.