Dollar gains, bonds fall on U.S. rate-hike fears

NEW YORK (Reuters) - The U.S. dollar extended gains and U.S. government debt prices fell on Monday on fears the Federal Reserve will hike interest rates sooner than expected after last week’s surprisingly strong jobs data.

The selling of bonds followed a steep sell-off on Friday after the U.S. Labor Department said employers cut far fewer jobs in May than had been forecast, sparking speculation that a recession might end this year and later spur higher rates.

Eurodollar futures on Monday priced in a rise in U.S. interest rates of almost 1 percentage point within a year after Friday’s payrolls report.

Oil fell to almost $68 a barrel on the stronger dollar and weakness in U.S. and European stocks.

U.S. stocks rebounded before the close, disregarding lowered iPhone prices from Apple AAPL.O and disappointing sales from McDonald's MCD.N.

Longer-dated euro-zone government bonds closed higher while their U.S. counterparts initially rose as the weakness in stocks boosted the allure of lower-risk fixed-income assets, driving the benchmark bund yield off a seven-month peak.

Longer-dated U.S. Treasuries later turned lower as the improving economic outlook sparked fears that the Fed will be forced to drop its near-zero interest-rate policy.

“The focus now is on the Fed actually tightening rates, sort of, into the fall,” said Thomas di Galoma, head of fixed- income rates trading at Guggenheim Capital Markets LLC in New York.

“Reality on the Fed is just changing. There was a feeling that the Fed would be able to leave rates at pretty much zero through 2009 and probably well into 2010,” he said.

The rate-sensitive two-year note fell 9/32 in price to yield almost 1.44 percent, the highest since early November and up from 0.96 percent late on Thursday.

Benchmark 10-year notes fell 17/32, pushing yields up to 3.91 percent from 3.84 percent at Friday’s close.

Gold futures ended below $950 an ounce as the dollar rose sharply on signs of an economic recovery, reducing the appeal of bullion as a hedge against a weakening U.S. currency.

The August gold contract tumbled 1.1 percent, or $10.10, to settle at $952.50 an ounce in New York.

The euro fell broadly after ratings agency Standard & Poor’s cut Ireland’s sovereign credit rating to AA, the country’s second downgrade by an agency in three months.

The downgrade provided a fresh catalyst to sell the euro, which fell to a nearly two-week low of $1.3806 and bolstered the dollar.

“The immediate reaction (to the downgrade) was to take the euro lower, which in any event, was trading heavily,” said Marc Chandler, senior currency strategist at Brown Brothers Harriman in New York.

The euro traded 0.48 percent lower at $1.3905.

The Dow Jones industrial average .DJI inched up 1.36 points, or 0.02 percent, to close at 8,764.49. The Standard & Poor's 500 Index .SPX fell 0.95 of a point, or 0.10 percent, to 939.14. The Nasdaq Composite Index .IXIC fell 7.02 points, or 0.38 percent, to 1,842.40.

The S&P 500 has rallied 39 percent since sliding to a 12-year closing low on March 9, leading to speculation a correction loomed, despite recent dips that have been short-lived.

“The market has been in an uptrend and ever since we broke through that 200-day moving average, the market has been acting pretty well,” said Todd Leone, head of listed trading at Cowen & Co. in New York. “You’re still seeing buyers out there.”

A rally in commodity prices helped limit losses of European mining and energy shares.

The pan-European FTSEurofirst 300 .FTEU3 index fell 0.8 percent to close at 865.11 points.

The dollar was up against a basket of major currencies, with the U.S. Dollar Index .DXY up 0.26 percent at 80.874. Against the yen, though, the dollar was down 0.15 percent at 98.49 yen.

U.S. crude fell 35 cents to settle at $68.09 a barrel, off a seven-month high of $70.32 hit on Friday. London Brent fell 46 cents to $67.88.

Japan's Nikkei share average .N225 rose 1 percent to fresh eight-month highs, helped by a report on Friday that showed fewer-than-expected U.S. job losses in May. MSCI's index of Asia Pacific stocks outside Japan .MIAPJ0000PUS slid further in after-hours trade, falling 2.1 percent.

Reporting by Tenzin Pema, Steven C. Johnson and Ellen Freilich in New York; Christopher Johnson, Ian Chua, Brian Gorman in London; and Vidya Ranganathan in Singapore; Writing by Herbert Lash; Editing by Jan Paschal