By Yasin Ebrahim
Investing.com -- The 2-year Treasury yield on Tuesday soared to its highest level since 2007 as Federal Reserve Jerome Powell's hawkish remarks ramped up bets on a return to aggressive rate hikes at the central bank's March meeting.
The 2-year Treasury yield, which is more sensitive to rate hikes, jumped 12 basis points to 5.021%, the highest level since 2007. The move rattled sentiment on risk assets, keeping the S&P 500 deep in the red.
The move arrived hours after Powell indicated the Fed could step up the pace of tightening after a downshift in February following strong economic data. About 67% of traders now expect the Fed to deliver a 50 basis point rate hike at its March 21-22 meeting, compared with just 24% prior to Powell's remarks.
"As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated," Powell said in testimony before the Senate Banking Committee on Tuesday.
The Fed chairman also said that “if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”
The hawkish repricing comes just days ahead of the monthly nonfarm payrolls that could all but cement expectations for a bigger rate hike in March should the report surprise to the upside.
"Chair Powell's prepared remarks for his semi-annual testimony opened the door to a return of 50bp hikes at the March meeting if the incoming data flow warrants it," Morgan Stanley said in a note. "Upside surprises to Friday's payroll report could drive a faster and longer tightening cycle."
The remarks from Powell caused shock and awe in the market as many hadn't expected the Fed chairman to endorse the recent upswing in bets on Fed hikes and definitely didn't foresee the return of a 50bps hike to the monetary policy table.
But the data from January on employment, consumer spending, manufacturing production, and inflation, according to Powell, have "partly reversed the softening trends" seen in the data just a month ago.
While some of the economic strength seen at the turn of the year could be attributed to the warm weather seen in January, the "breadth of the reversal along with revisions to the previous quarter suggests that inflationary pressures are running higher than expected at the time of our previous Federal Open Market Committee meeting," Powell conceded.
The Fed has long singled out the strong labor market as one of the main threats to its mission to tame inflation, particularly in the core services sector, excluding housing, where wages are the dominant force of price pressures.
"[T]here is little sign of disinflation thus far in the category of core services excluding housing, which accounts for more than half of core consumer expenditures. To restore price stability, we will need to see lower inflation in this sector, and there will very likely be some softening in labor market conditions," Powell said.