On the early morning of March 8th, during a Senate committee hearing, Federal Reserve Chair Jerome Powell delivered a significant semi-annual economic and monetary policy report, facing questions from lawmakers.

In light of recent robust employment and inflation data, Powell indicated that the Federal Reserve may accelerate the pace of interest rate hikes, potentially raising rates to levels higher than previously anticipated.

As a result of these hawkish comments, U.STreasury yields surged across the board, with the difference in yield between 2-year and 10-year Treasuries widening to 105 basis points, the steepest inversion since September 1981. Other yield curves also experienced a deepening inversion, particularly between the 2-year and 30-year bonds, reaching record levelsTypically, such a pronounced inversion raises market concerns about a potential economic recession.

All three major U.S. stock indices declined significantly; the Dow Jones fell by 574.98 points, closing down 1.72% at 32,856.46 points; the Nasdaq dropped 145.41 points, or 1.25%, to end at 11,530.33 points; and the S&P 500 was down by 62.05 points to 3,986.37 points, reflecting a 1.53% decreaseMeanwhile, the U.S. dollar index rose by 1.20% to 105.5995.

Possibility of a 50 Basis Points Rate Hike in March

In his prepared remarks, Powell reiterated that the journey to curtail inflation may be challenging, and the unexpectedly strong economic data signifies that the terminal interest rates may be higher than the Federal Reserve's earlier projections.

He indicated that continuing to raise policy rates could be appropriate, as history warns against prematurely easing monetary policies

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The Fed is closely monitoring the lagging effects of monetary policy, suggesting that the ultimate rate levels may exceed expectations.

However, Powell emphasized that decisions regarding interest rates will be made “on a meeting-by-meeting basis” and will depend on data and its impact on inflation and economic activity rather than a preset path.

As per projections from December, officials believed the terminal rate might be around 5.1%. However, according to the latest CME FedWatch Tool, the probability of a 50-basis point increase in March has surpassed that of a 25-basis point hike, reaching 70.5%. By May, the cumulative odds of a 50-basis point increase are estimated at 22.1%, while the probability of raising rates by 75 basis points to the 5.25%-5.50% range stands at 60.3%, and a cumulative hike of 100 basis points to the 5.50%-5.75% range at 17.6%.

Goldman Sachs anticipates that the Fed will also raise rates in July, adjusting its peak rate expectation upwards by 25 basis points to the 5.5%-5.75% range, while BlackRock's CIO suggests the Fed may ultimately raise rates to 6%.

Tracy Chen, a portfolio manager at Brandywine Global Investment Management, remarked, “Powell's hawkish stance this time is double-edged – signaling both a higher peak rate and an accelerated pace for interest rate hikesGiven the recent inflation data, his earlier inclination to reduce the hike to 25 basis points may have been premature; this adjustment helps mitigate the risk of the Fed falling behind the curve.”

Core Inflation Remains Elevated

Since early January, a series of economic data have surpassed expectations

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The Consumer Price Index (CPI) for January showed a lesser-than-expected deceleration year-over-year, while the core Personal Consumption Expenditures (PCE) price index registered a 4.7% year-over-year increase, marking its first rise after six months of declineThe labor market remains robust, with initial jobless claims falling below 200,000 for seven consecutive weeks, reflecting levels comparable to pre-pandemic timesNon-farm payroll additions in January reached 517,000, about 2.8 times the market expectation, pushing the unemployment rate down to 3.4%, the lowest level in over 53 years.

Powell noted that since he testified before Congress last year, inflation growth in the U.S. has somewhat eased, but rates remain significantly above the Federal Reserve's long-term target of 2%. To effectively reduce inflation to that target, a decrease in core services inflation (excluding housing) is necessary, and it is likely that some softening in the labor market will need to occur.

Moreover, Powell pointed out a clear mismatch between labor supply and demandThe Federal Reserve must make efforts to improve the alignment between job market supply and needsCurrently, the employment rate in the U.S. has surpassed most market participants' estimates of a "full employment level."

Notably, the Q&A session revealed the most contentious debate surrounding the unemployment rateLawmakers from both parties insinuated that the Federal Reserve seeks to elevate the unemployment rate in an effort to tame inflationFor instance, Democratic Senator Elizabeth Warren highlighted that the Fed anticipates the unemployment rate will rise by more than a percentage point from current levels, reaching 4.6% by the end of the year, which could lead to two million workers losing their jobs

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