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Hawkish Powell prompts surge in yields as the dollar reaches a 3 month high

On Wednesday, the U.S. dollar reached a three-month high against a basket of currencies as Treasury yields spiked after Federal Reserve Chair Jerome Powell indicated that interest rates would likely increase more than the market had expected. The dollar index and dollar index futures both rose approximately 0.2% during Asian trade, reaching their highest levels since early December. Both instruments also surged by around 1.3% on Tuesday.

During his testimony before Congress, Powell said that the Fed would probably raise interest rates more than market expectations, citing the recent resilience of the U.S. economy. This news caused markets to quickly begin pricing in a greater chance of a 50 basis point hike in March, up from prior expectations of a rise of 25 bps.

U.S. Treasury yields also surged overnight, with a bias towards short-term yields. This caused a further deepening of the yield curve, with spreads between two-year and 10-year yields close to their lowest level since October. Two-year yields also surged past 5% for the first time since 2007.

Powell’s comments came after stronger-than-expected inflation and labor market readings for January indicated that the Fed would likely need to tighten policy further to ensure a sustained downtrend in inflation. The central bank had hiked rates by a cumulative 450 basis points since March 2022 to an upper range of 4.75%, and market positioning for a terminal rate of around 5.5%.

However, with inflation still showing signs of stickiness, markets are now positioning for rates potentially breaching 6%. This week’s focus is largely on the Fed and the labor market, with the central bank’s Beige Book report on the economy due later on Wednesday. Nonfarm payrolls data for February is due on Friday, and any signs of strength in the economy could give the Fed more headroom to keep raising rates.

Rising interest rates have caused concerns about a sharp slowdown in the U.S. economy later this year. An inverted yield curve is considered a classic signal that traders are positioning for a potential recession.

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