Bonds News

US RATE FUTURES-Snuffing out prospects for '07 Fed cuts

CHICAGO, April 9 (Reuters) - Short-term interest rate futures stayed defensive on Monday, cutting the implied prospects for Federal Reserve rate cuts in 2007 further in the first full day of reaction to Friday’s U.S. payrolls report.

The Labor Department's Easter surprise, showing March job creation well above expectations, pushed the chance for a Fed ease by June .FFN7, as measured in futures, to 10 percent from about 30 percent in late March.

Futures suggest a year-end federal funds rate .EDZ7 of 4.97 percent versus 4.81 percent before the jobs data. For much of March, futures hinted that the Fed would cut rates two or three times before year-end from the current 5.25 percent.

“Interest rate futures have taken the Fed out of the picture,” said strategists at Action Economics.

March nonfarm payrolls growth was 180,000, above the Wall Street consensus centered on 120,000, and the highest monthly total since December. February and January jobs growth was revised up as well, and the jobless rate fell to 4.4 percent to match the cycle low for October.

“No room for rate relief can be entertained in a world of low -- and falling -- unemployment,” said Robert Barbara, economist at ITG Hoenig in Rye Brook, New York.

“The next move for the fed funds rate, we continue to believe, will be down. But before that occurs we need to see the jobless rate move up.”

Barbara said that in the current tight labor market many companies are loath to fire staff but have looked at other ways to trim costs, such as cutting hours.

A series of soft economic reports recently has had analysts trimming their first-quarter growth estimates, but it was back to the drawing board for some after the payrolls shocker.

“The downside economic risks story cannot be validated without a rise in the unemployment rate,” said Christopher Rupkey, senior economist at Bank of Tokyo-Mitsubishi UFJ in New York.

Rupkey looks for a steady fed funds rate through midyear. Beyond that there could be adjustments in either direction depending on the data, he said. In fact, growth may need to stay sub-par to avoid igniting inflation fears even further.

“Real GDP has to remain at or below 2.75 to 3 percent potential or the Fed will start talking about rate hikes because the core PCE deflator is uncomfortably high for them,” he said.

Traders on Monday eyed a spike in future inflation expectations shown by prices of U.S. inflation protected securities, or TIPS, following the jobs report. The jump in TIPS, which are closely monitored at the Fed, suggests less confidence that inflation rates will fall.

“The elevated state of inflation is not a temporary phenomenon,” economists at Lehman Brothers said in a research note. “The Fed cannot ease up on fighting inflation without taking a severe hit to its credibility.”

Futures traders also fear fresh inflation pressure from commodity prices. The Reuters/Jefferies Commodity Research Bureau index .CRB, which measures futures prices for 19 commodities, is back up to late-December levels.