'Hawkish' Powell's Big Step Emerges... 2-Year Bond Yield Surpasses 5% (Comprehensive)

Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), stated on the 7th (local time) that "the terminal interest rate could be higher than previously expected," reinforcing tightening measures and causing turbulence in the financial markets. Due to his more hawkish-than-expected remarks, the possibility of a 'big step' (a 0.5 percentage point increase in the benchmark interest rate) in March has sharply risen, leading to a steep decline in the New York stock market. The yield on the 2-year U.S. Treasury note, sensitive to monetary policy, surpassed 5% for the first time since 2007, and the inversion spread between the 10-year and 2-year Treasury yields widened to its largest margin since 1981.

◆"Ready to speed up" Powell signals tightening...Big step possibility grows

At the Senate Banking Committee hearing that day, Chairman Powell said, "Recent economic indicators have all come out stronger than expected," suggesting that the terminal rate level could be higher than previously anticipated." He emphasized, "If the overall data require faster tightening, we are ready to increase the pace of rate hikes." He added, "There is still a long way to go to bring down inflation," and "Maintaining a restrictive monetary policy stance for some time is necessary to restore price stability."

These remarks are interpreted as leaving the door open for a big step at the Federal Open Market Committee (FOMC) meeting scheduled for March 21-22. Recently, inflation, employment, and consumer indicators have all shown strong levels, leading the market to speculate that the Fed may accelerate the pace of rate hikes again. Since the tightening cycle began in March last year, the Fed has raised U.S. interest rates to 4.5-4.75%, the highest since 2007. Following Powell's comments, the Fed's projected rate hike path on the dot plot to be released at the March FOMC is also expected to rise. Previously, the median terminal rate on the dot plot released by the Fed in December last year was 5.1% for the end of this year.

[Image source=Reuters Yonhap News]

Powell diagnosed, "The easing trend in inflation seen just a month ago has partially reversed in January's employment, consumer spending, production, and inflation indicators," adding, "Inflationary pressures are higher than the previous FOMC forecast." He noted, "Strong measures have been taken over the past year, but the full effect of tightening has not yet been realized," and "No indicator shows that we have tightened enough."

In particular, Powell expressed renewed concern about the strong inflationary pressures in the services sector. He said, "We are watching the services sector very closely." Furthermore, he evaluated, "There has been little evidence of disinflation in core services excluding housing," and "To bring inflation down to the 2% target, disinflation in core services and easing in the labor market are necessary."

On that day, Powell did not specify concrete figures regarding the future size of rate hikes or the terminal rate, stating that these will be "determined by the data." He explained that it depends on indicators such as the employment report to be released later this week before the FOMC meeting and the consumer price index (CPI) next week. However, due to his hawkish remarks, the market increasingly expects that the Fed, which reduced the rate hike size to 0.25 percentage points at the February FOMC, could expand the hike size again in just one month.

According to the CME FedWatch, the federal funds (FF) futures market currently reflects nearly a 70% chance of a big step in March. This figure surged sharply from the 31% range the previous day and was only about 9% a month ago. Additionally, the futures market most strongly reflects the possibility that the terminal rate could rise to 5.5-5.75% this summer. Considering the current U.S. rate of 4.5-4.75%, this implies a potential additional 1 percentage point increase.

Powell also reaffirmed caution against premature easing policies. He emphasized, "Historical cases warn against easing policy prematurely," and "We will stay on this path until the job is done. We will do everything possible to achieve maximum employment and price stability."

◆Markets shaken by hawkish remarks...Could terminal rate reach 6%?

The market is flooded with assessments that Powell's remarks are hawkish. His statement that the pace of tightening can be increased if necessary has put the possibility of a big step immediately on the table, and some analyses do not rule out a terminal rate in the 6% range.

Investment bank Morgan Stanley said in an investor note that "Powell's remarks opened the possibility of a 0.5 percentage point hike in March," and that the pace of tightening could accelerate depending on the employment report to be released on the 10th. Michael Brown, strategist at TraderX, also described the remarks as "surprisingly hawkish," predicting that the terminal rate could reach 6% depending on employment data.

Nonfarm payrolls for February are estimated to increase by 225,000. If the employment report again shows a stronger-than-expected level as it did a month ago, the possibility of a big step will gain more weight. This will inevitably act as a factor weighing down the financial markets immediately. Economic media CNBC also reported, "Powell's comments on economic indicators suggest that the February employment report, to be released on Friday, could be a much more important factor in this month's Fed rate hike decision."

On the other hand, analyses that the possibility of an immediate big step shift is low continue. The Fed may be cautious about damaging its credibility if it returns to a big step just one month after slowing the pace of rate hikes. Peter Boockvar of Bleakley Financial Group said, "I don't think the Fed will go back to a 0.5 percentage point hike at this point after already slowing down," and predicted, "They will continue with 0.25 percentage point hikes until they stop the cycle."

The New York stock market is showing a broad decline. Ahead of the afternoon close that day, the S&P 500 index, centered on large-cap stocks, fell 1.57%, and the Nasdaq index, sensitive to interest rates and focused on technology stocks, dropped 1.28%.

The inversion between short- and long-term U.S. Treasury yields widened to the largest margin since 1981. That afternoon, the 2-year yield surpassed 5% for the first time since 2007. The inversion spread between the 2-year yield (5.015%) and the 10-year yield (3.973%) exceeds 1 percentage point. The yield curve inversion, where the long-term 10-year yield falls below the 2-year yield, is generally considered a precursor to a recession.

The dollar index, which measures the value of the U.S. dollar against the currencies of six major countries, surpassed the 105.6 level, soaring to its highest point in about two months.

eToro's Kali Cox said, "The Fed's top priority is to lower inflation," expressing concern that "people are beginning to consider that high inflation will persist. This could be the worst-case scenario for long-term investors."

This content was produced with the assistance of AI translation services.