By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) - Futures on the federal funds rate on Wednesday have priced in a roughly 80% chance of a quarter-percentage-point rate hike by the Federal Reserve at the March meeting following the release of the U.S. central bank's minutes of its last policy meeting.
For the year, rate futures are implying about three rate increases in 2022.
Fed officials said last month the U.S. labor market was "very tight" and might need the Fed to raise interest rates sooner than expected but also reduce its overall asset holdings to tame high inflation, according to minutes of the central bank's Dec. 14-15 policy meeting.
Some participants also noted that it could be appropriate to begin reducing the size of the Fed's balance sheet relatively soon after beginning to raise the fed funds rate. The size of the Fed's balance sheet is estimated at $8.5 trillion.
"The tone of the minutes suggested that they're going to start earlier and could extend the tightening. They are very afraid of inflation getting out of hand," said Kim Rupert, managing director, fixed income, at Action Economics.
"Looking to shrink the balance sheet more quickly than we thought, that might limit the extent of rate hikes and I think the Fed even sort of mentioned that."
After the Fed's mid-December meeting, rate futures had fully priced in the first hike by May this year.
U.S. yields surged and the curve flattened after the Fed minutes as investors braced for what could be multiple hikes that should push short-term rates higher. [US/]
Some analysts viewed prospects of a March rate hike though as too aggressive given the likely moderation in growth amid the surge in COVID-19 cases and possible easing of inflation.
"March is definitely aggressive, but the market is ahead of the Fed. I would say it's more May or June," said Ellis Phifer, managing director, fixed income research at Raymond James.
"If you get data showing pricing pressures and delivery times are easing, I would imagine that would push rate hikes back a little bit...I think we are near peak inflation for the year.