Hedge funds and other investors have sharply reduced their bullish dollar positions as changing Federal Reserve rate expectations and a renewed yen rally weigh on the US currency, according to a report by Bloomberg.

The Bloomberg Dollar Spot Index is heading for a weekly decline of about 0.7% after falling to its lowest level since May on Thursday. Markets have scaled back expectations of a Federal Reserve rate increase at its 16 September meeting, with traders now assigning roughly even odds to a hike.

Comments from Fed Governor Christopher Waller pointing to further progress on inflation have added to the pressure on the dollar, while concerns surrounding the US fiscal outlook continue to weigh on sentiment.

At the same time, the yen is on course for its strongest week since July, having gained around 2.7% against the dollar. Investors are increasingly betting that the Bank of Japan will raise its benchmark rate by 25 basis points this month, while maintaining flexibility to accelerate the pace of tightening later.

The next major test for the dollar will come from US economic data. Payrolls figures due Friday are expected to show the unemployment rate remaining at 4.1% in August, while consumer-price data due next week could prove critical for determining whether the Fed has scope to keep rates unchanged this month.

A benign inflation reading could further undermine the case for a September hike and extend the dollar's recent decline.

Positioning data suggests investors had already started reducing exposure to a stronger dollar before the latest selloff. Hedge funds, asset managers and other speculative traders held around $27.6bn of net dollar longs in the week to 25 August, according to Commodity Futures Trading Commission data.

That represented a substantial decline from almost $50bn at the end of July, when bullish dollar positioning reached its highest level since 2014.

The reversal could have further room to run if US rate expectations continue to shift and the yen maintains its momentum.