US RATE FUTURES-Jobs report puts Fed 2009 rate hikes in play

CHICAGO, June 5 - The prospect of an interest rate increases from the Federal Reserve by year-end was back in play on Friday in futures markets after May's U.S. payrolls report was far less weak than expected and Fed officials urged not waiting too long to start reversing highly accommodative policy.

U.S. short-term interest rate futures, which track market expectations for Fed rate policy, Friday had their first meaningful move in months -- pushing the possible timing of the first Fed rate hike to late 2009 from early 2010.

"The combination of the stronger than expected US employment report and two Fed officials in the past 24 hours talking about not waiting too long to hike rates has seen the Fed funds futures sell-off sharply," said Marc Chandler, currency strategist at Brown Brothers Harriman in New York.

In trading on the Chicago Board of Trade, rate futures now fully price an increase in the funds rate to 0.5 percent at the December Federal Open Market Committee meeting, after showing just a 56-percent chance of such an outcome late on Thursday.

The funds rate has been set by the Fed in a range of zero to 0.25 percent since December in response to a sharply deteriorating economy.

By mid-2010, the projected funds rate jumped to 1.22 percent from 1.01 percent.

The U.S. Labor Department said another 345,000 payroll jobs were lost in May, not as bad as the consensus forecast for a loss of 520,000. Job losses for March and April were revised to be smaller as well, by a total of 82,000.

At the same time, the May jobless rate reached a higher than expected 9.4 percent from 8.9 percent in April, its highest level 1983.

"Based on the latest job count readings, it looks like the economy has hit bottom and the recession is all but over," said Chris Rupkey, senior financial analyst at Bank of Tokyo-Mitsubishi UFJ in New York.

The day's tone in rate futures also reflected hawkish comments from Atlanta Fed President Dennis Lockhart, who said in an interview with Market News that the Fed should not wait too long to tighten monetary policy.

Lockhart's remarks followed the tone set by Kansas City Fed President Thomas Hoenig on Thursday. The veteran policy-maker issued a stern warning on inflation risks.

"There are hawks at the Fed and they have not been beaten into submission by the crisis," Chandler said.