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U.S. Rate Futures Brace for Diet of Fed Hikes

Fri Nov 5, 2004
By Ros Krasny

CHICAGO (Reuters) - Short-term interest rate futures plunged on Friday after U.S. October jobs growth was far above expectations, raising the potential for a Federal Reserve interest rate increase in December.

Futures fully price another quarter percentage point increase to target rates at the Federal Open Market Committee policy-setting meeting on Wednesday.

Chances of another increase in December, which have been hovering near 50 percent, jumped to about 80 percent.

"This now puts the Fed in play for December," said Cary Leahey, senior U.S. economist at Deutsche Bank Securities. "Still, (Fed Chairman Alan) Greenspan hasn't raised rates in December in 15 years."

Futures contracts, such as Eurodollars, measure market expectations on shifts in the Federal Reserve's monetary policy, as measured by the level of short-term interest rates.

A Reuters poll of 20 top bond dealers on Friday showed 10 believing the Fed will raise rates in December as well as November, up from six in an October survey.

That would take the fed funds rate to 2.25 percent by year end. The FOMC has raised the rate three times since June from a low of 1.0 percent.

Deferred Eurodollar futures sustained bigger losses as traders anticipated more Fed rate increases in 2005. Eurodollars imply a fed funds rate near 2.55 percent by the end of March.

The U.S. economy added 337,000 non-farm payroll jobs in October, the Labor Department said, compared with the median Wall Street forecast of 169,000. Payroll growth for September was revised up to 139,000 from the initial 96,000, and August was also revised higher, to 198,000 from 128,000.

The U.S. jobless rate rose to 5.5 percent after two months at 5.4 percent, suggesting discouraged job seekers might be starting to look for work again. The pool of available workers rose by 4.4 percent in October.

Some of October's outsized payrolls growth was attributed to hurricane-related cleanup in the Southeast. Construction jobs jumped by 71,000 on the month while manufacturing employment slipped for a second month.

"Even extracting effects from the hurricanes, I think this is an economic expansion and it's here to stay," said Anthony Chan, senior economist at J.P. Morgan Fleming Asset Management, Columbus, Ohio.

Further out on the yield curve, the biggest job gains since March pushed Treasury futures down sharply.

"A lot of bond investors were skeptical that we would see strong job growth," said Gary Thayer, chief economist at A. G. Edwards & Sons, St. Louis.

The jobs numbers will support consumer spending going into the holiday shopping season, he said.

Losses in futures were exaggerated by chart-driven long liquidation in markets such as 10-year notes, where speculators such as hedge funds hold huge long positions.

As of Tuesday speculators were long a net 101,527 contracts in Chicago Board of Trade 10-year notes, down 23,940 contracts on the week but one of the highest levels ever, the Commodity Futures Trading Commission said in a weekly report.


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