U.S. yields on the shorter end of the curve soared on Thursday after Federal Reserve Chairman Jerome Powell flagged multiple interest rate increases this year, citing the economy's strong labor market and persistently high inflation.

The U.S. 2-year yield, which reflects interest rate expectations, surged to 1.208%, a nearly two-year peak. The U.S. 5-year yield, which is also an indicator of the market's rate outlook, climbed to 1.701% overnight, the highest since December 2019. But 5-year yields have since traded little changed on the day.

Traders in the fed funds futures market moved to price in nearly five rate hikes this year in the wake of Powell's remarks on Wednesday as the Fed held interest rates steady at its monetary policy meeting.

Prior to the Fed meeting, rate futures showed about four rate increases for 2022. For the March meeting, fed funds futures have factored about 31 basis points of tightening, while a 50-basis point hike implied a 20% probability.

Powell Says Rates Can Go Higher
Without Disrupting the Labor Market

Powell on Wednesday said there is "quite a bit of room to raise interest rates without threatening the labor market that is by so many measures historically tight."

"The Fed is okay with the market pricing in more tightening because that's doing the heavy lifting for them," said Gennadiy Goldberg, senior rates strategist at TD Securities in New York. "To some extent, I don't think they need to tighten policy six times this year or seven times as some banks had suggested, but the takeaway is earlier and more aggressive rate hikes," he added.

In late morning trading, U.S. 2-year yields were last up nearly 8 basis points to 1.1683%, while 5-year yields were up 1 basis point at 1.6550%. The benchmark 10-year yield slid 3 basis points to 1.8119%, while 30-year yields fell 6 basis points to 2.1016%.

The drop in long-dated yields flattened the yield curve, as traders braced for imminent rate hikes. The gap between 2-year and 10-year yields fell to 62.8 basis points, the narrowest since late November.

Another yield curve measure, the spread between 5-year and 30-year yields also declined to 42.4 basis points , the flattest in two weeks.

"With inflation at 7%, it's understandable that markets are taking being unsure about the appropriate path as being hawkish," said Peter McCallum, rates strategist at Mizuho in London. "So I'm not surprised to see more hikes priced into this year."

January 27 Thursday 10:36AM New York / 1536 GMT Price Current Net Yield % Change (bps) Three-month bills 0.1925 0.1953 -0.005 Six-month bills 0.42 0.4267 0.036 Two-year note 99-107/256 1.1703 0.079 Three-year note 99-50/256 1.4031 0.062 Five-year note 99-70/256 1.6518 0.007 Seven-year note 97-90/256 1.7833 -0.017 10-year note 96-28/256 1.8101 -0.036 20-year bond 97-36/256 2.1785 -0.053 30-year bond 95 2.1016 -0.064 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 14.00 0.50 spread U.S. 3-year dollar swap 13.75 -0.25 spread U.S. 5-year dollar swap 6.50 -0.25 spread U.S. 10-year dollar swap 5.75 -0.25 spread U.S. 30-year dollar swap -17.00 1.25 spread.