GRAPHIC-Market bets on Fed rate hike surge

(Updates market pricing and probabilities in first two paragraphs and in graphics)

By Ann Saphir

March 20 (Reuters) - Market pricing for a U.S. Federal Reserve interest-rate hike this year has shot up, and is now seen as far more likely than a rate cut.

On Friday, interest-rate futures were pricing around a 25% chance of a rate hike by December, based on the CME FedWatch tool.

In payoff terms, a trader selling a December rate-futures contract at Friday's price -- effectively betting on a quarter-point rate hike -- stood to profit by roughly as much if the Fed tightens in December as a buyer betting against a hike would if it leaves rates unchanged.

Five days ago, the market had no hint of a rate-hike expectation at all this year, and indeed showed traders firmly believed the Fed's next move would be to reduce borrowing costs. That is a huge swing. As recently as last month, financial markets reflected expectations for as many as two interest-rate cuts by the end of the year. For the first couple of weeks of the Iran conflict that began on February 28, markets continued to think the Fed would ease policy, looking through the effect of higher oil prices. Fed policymakers largely echoed that view. The reversal began this week as the Iran conflict escalated and Fed Chair Jerome Powell indicated he did not believe the risks to the job market outweighed risks to inflation. On Thursday and Friday, the shift gathered steam, particularly after Fed Governor Christopher Waller, an influential dovish voice at the central bank, said the risk of persistent inflation arising from the war with Iran was strong enough to convince him to cast his vote for keeping interest rates on hold this week, instead of cutting them as he had previously thought he would. Stocks have dropped and the yield on the two-year Treasury note - which closely tracks the direction of Fed policy - jumped. The two-year Treasury yield at the end of trading on Friday at 3.89% exceeded the Fed's effective daily policy rate by 25 basis points, the most it has done so in three years. That previous instance was more than a year into the Fed's aggressive tightening cycle in response to the inflation that erupted after the COVID-19 pandemic.

(Reporting by Ann Saphir; Editing by Rod Nickel)