Markets are pricing in higher odds of a bigger Fed rate hike this month as Powell delivers hawkish testimony and key bond yields top highest level since 2007

The road to 2% inflation will be "bumpy," Powell told senators on Tuesday, driving up bets the Fed will hike rates by 50 basis points in March.

• Bets that the Fed will reaccelerate the pace of rate hikes in March flew higher Tuesday. 
• Fed funds futures pricing suggests 61.6% odds of a half-point increase, up from 31.4% on Monday. 
• Getting inflation back to 2% "is likely to be bumpy," Fed Chair Jerome Powell told senators.  

Expectations the Federal Reserve will reaccelerate rate hikes surged Tuesday, driving down stocks and other financial assets as Fed boss Jerome Powell said policymakers have a "long way to go" to hit their inflation target. 

There's a 61.6% probability the Fed will raise its benchmark rate by 50 basis points on March 22, according to the CME FedWatch tool tracking fed funds futures pricing. That's up from 31.4% a day earlier. 

That suggests investors increasingly anticipate the Federal Open Market Committee will beef up its rate increase after hiking by 25 basis points at its last meeting and 50 basis points before that. The slowdown followed four straight increases of 75 basis points.

"Although inflation has been moderating in recent months, the process of getting inflation back to 2% has a long way to go, and is likely to be bumpy," Powell told the Senate Banking Committee, the first of two-day testimony on Capitol Hill. 

"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." 

For the Fed's May 3 meeting, futures pricing indicated a 18.4% chance of another half-point rate hike, up from 3.5% odds on Tuesday. The probability for a move of 25 basis points was still larger, at 56.3%. 

The fed funds rate currently stands at a range of 4.5%-4.75%. And with a bigger rate likely in store for March, the 2-year Treasury yield — which is especially sensitive to Fed-rate expectations — jumped closer to 5%, further cementing its footing at a 16-year high. The yield climbed to 4.979% a day prior. 

The yield on the 2-year note towered over the 10-year Treasury yield, which was at 3.963%, highlighting the ongoing yield curve inversion that's considered a recession warning. 

"Yield on 2-year US government #bonds is at levels not seen since 2007 and #markets now favor a 50 bps hike this month," economist Mohamed El-Erian said Tuesday on Twitter. "Such a reversal in rate policy, while warranted by a "data dependent" #Fed, would aggravate its damaged credibility after the earlier two mistakes in this cycle," he said. 

Stocks fell, pushing the S&P 500 down by 1.2% and the Dow Jones Industrial Average down by nearly 500 points. The Nasdaq Composite slipped 0.7%. 

"While some market participants might have been caught off guard by Powell's comments, the reality is that he is largely affirming what the bond market has already priced in," Charlie Ripley, senior investment strategist at Allianz Investment Management, said in a note. "The terminal level for policy rates will be slightly higher than previous expectations as the timing of an economic slowdown has been pushed further down the road."