Market Snapshot: Dow, S&P 500 book worst day in 2 weeks as Powell’s hawkish tone sparks concerns over higher interest rates

What drove markets

“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 prepared remarks to the Senate Banking Committee on Tuesday morning. “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.”

In February, the Fed raised the federal-funds rate by 25 basis points, a much slower pace after a half-point move in December and four jumbo 75 basis-point rate increases last year. However, Powell’s testimony to Congress on Tuesday hinted that the Fed may consider reupping the size of their next rate increase to half-of-a-percentage-point at its next policy meeting on March 21-22.

Following Powell’s hawkish remarks, Fed-funds futures traders were pricing in an over 70% chance of a 50 basis point rise in March, according to the CME FedWatch tool. Traders had seen only a 30% chance of a half-percentage-point hike in the previous session, and a 3.3% chance a month ago. That would take the main policy rate target to between 5% and 5.25%.

The sizzling January employment and inflation data have led some investors to bet on a terminal fed-funds rate of around 5.5%, or even as high as 6%, up from the FOMC’s average December projection of between 5% and 5.25%. This repricing led to a sharp stock-market selloff last month amid rising Treasury yields.

See: U.S. stock market skids Tuesday, spooked by Fed’s Powell tough talk on interest rates and 5% Treasury yields

Brad Conger, deputy chief investment officer of Hirtle Callaghan & Co, said Powell’s remarks were “completely consistent” with the message of being “data dependent.”

“New information has definitely been that the economy has reaccelerated, or the pace of deceleration has slowed down. I think he had no choice but to flag that 50 basis point was back on the table, so I am surprised that the market was surprised,” Conger told MarketWatch via phone.

The policy-sensitive two-year Treasury yield TMUBMUSD02Y, 5.023% finished above 5% on Tuesday afternoon. That was the highest level since June 2007, according to Dow Jones Market Data.

The ICE U.S. Dollar Index DXY, +1.21%, a measure of the currency against a basket of six major rivals, jumped 1.2% to 105.63, its highest level since December.

Fed officials are playing “a game with a moving target,” Conger said, adding that because inflation isn’t responding in the way they would have thought, the only option is to apply more restrictive borrowing conditions “and then see what happens.”

“Powell has a great way of smoothing over the rough spots. I think what caught people by surprise is the unvarnished hawkishness, rather than his comments where he can sometimes balance his hawkishness with something more market friendly,” Steve Sosnick, chief strategist at Interactive Brokers IBKR, +0.44%, said in a phone interview.

Maybe some investors were growing “complacent” that the story line would be a gradual easing of interest rates, but Sosnick said Powell’s stance is “very much in line with data dependence” that Powell has been emphasizing. That puts extra urgency on what the numbers reveal Friday in the February jobs report, he said.

Indeed, Powell said that there are “two or three very important data releases to analyze” before the time of the March meeting.

“Those are going to be very important in the assessment we have of this relatively recent data,” he said.

The semiannual testimony comes days ahead of the latest monthly jobs report and the monthly inflation report next Tuesday. Economists surveyed by The Wall Street Journal expect February payrolls to have grown by 225,000, while the unemployment rate remained unchanged at 3.4% from a month ago.

See: What’s next for stocks after Fed’s Powell triggers market-rattling rate jolt

Powell will also be quizzed by the House of Representatives’ Financial Services Committee on Wednesday at 10 a.m. Eastern.

Economic data releases Tuesday include January wholesale inventories, which declined for the first time since mid-2020. The numbers, matching the estimates of economist polled by The Wall Street Journal, indicate businesses are shrinking their amount of unsold goods to correspond with softening consumer demand. Reports on January consumer credit are slated for release at 3 p.m.

Companies in focus

• Dick’s Sporting Goods Inc. DKS, +11.09% shares ended 11.1% higher on Tuesday after the retailer beat estimates on its fourth quarter results and offered a muscular full year earnings outlook.
• Meta Platforms Inc. META, -0.21%  shares were down 0.2% amid a report that the parent company of Facebook and Instagram is eyeing another round of layoffs. Any extra trim to the workforce, as reported by Bloomberg News, would follow layoffs late last year of more than 11,000 employees.
• Shares of WW International Inc. WW, +79.07%, the company also known as Weight Watchers, rallied more than 79%. The stock move comes after the company reported its fourth quarter results late Monday, also in the wake of Wall Street Journal reports that it was buying the telehealth platform Sequence.
• United Airlines Holdings gained nearly 3% after the Justice Department sued to block JetBlue’s JBLU, -2.86% acquisition of budget carrier Spirit Airlines SAVE, +4.71%.  Shares of JetBlue Airways dropped 2.9%, and shares of Spirit Airlines jumped 4.7%.

— Jamie Chisholm contributed to this article