US RATE FUTURES-Taste for Fed rate hikes proves fleeting

By Ros Krasny

CHICAGO, July 24 (Reuters) - U.S. interest rate futures rallied sharply on Thursday, driving down the implied chances for Federal Reserve rate rises as recent hawkish Fedspeak gave way to fresh economic jitters.

Weekly jobless claims jumped to a surprisingly high 406,000 from 372,000, the highest reading since late March, prompting some firms to revise down their forecasts for July nonfarm payrolls.

"Everything we see supports the conclusion that the labor market is contracting, but not imploding," analysts Philippa Dunne and Doug Henwood of the Liscio Report said in a research note.

On the heels of the claims report, U.S. existing home sales were reported down 2.6 percent for June, and the volume of sales hit a 10-year low.

"It just underscores that the U.S. economy is by no means out of the woods," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto.

The Federal Open Market Committee next meets to consider interest rates on Aug 5, and futures show only a 5-percent chance for a rate increase.

Prospects for a quarter-point hike in September, to 2.25 percent from the current 2 percent, fell as low as 40 percent from Wednesday's 68 percent.

By year-end, the fed funds rate is projected at 2.27 percent, down from 2.44 percent on Wednesday. Prospects for higher rates in the first quarter of 2009 were also savaged.

Gains in futures, which move inversely to the implied prospects for rate increases, accelerated as the recent in U.S. equities stalled abruptly, pushing the Dow Jones industrial average to a 2.35 percent loss.

Analysts said a recent focus on comments from some regional Fed presidents, urging interest rate increases before the economy and financial markets get back on an even keel, had been overplayed.

Instead, the FOMC is likely to take its lead from Chairman Ben Bernanke and stay focused on financial market stability for the time being.

Stabilization in the housing market is seen as a key hurdle to a rate increase, and the most up-to-date reports suggest that is still some way off.

"Lending standards in the mortgage market have remained tight while consumers have become increasingly pessimistic about the economic outlook. In addition, while home prices have fallen sharply, it is unlikely they have reached a bottom," said Michelle Meyer, economist at Lehman Brothers.