By Herbert Lash

NEW YORK, March 22 (Reuters) - A sell-off in U.S.
Treasuries eased a bit on Tuesday with a key part of the yield curve holding just above a two-year low hit earlier as traders wagered on big interest rate hikes in coming months after Federal Reserve Chair Jerome Powell rattled bond markets.

Powell said on Monday the Fed needed to move "expeditiously" to combat rising inflation and he raised the possibility of 50-basis-point hikes instead of a series of six 25-basis-point hikes for the rest of 2022 the central bank outlined last week.

"The bond market is now fairly convinced of an aggressive policy stance from the Fed and will continue to see rates gravitate higher," said Kim Rupert, managing director of global fixed income analysis at Action Economics.

"The markets will kind of settle down," she said.

"They do that spike, they move aggressively and violently, and then there's a period of calm. So I foresee that, but it's going to be with higher rates."

The yield on benchmark 10-year Treasury notes rose 4.9 basis points to 2.366%, while the gap between yields on two- and 10-year Treasury notes was at 17.9 basis points, indicating a potential economic downturn lies ahead.

Earlier, the closely watched part of the yield curve narrowed to as low as 13.5 basis points.

The market is pricing in a 72.2% probability that the Fed will hike the fed fund rates 50 basis points when policymakers meet in May, up from just over 50% on Monday.

"This is going to be a fast hiking cycle and the markets are getting increasingly skeptical about the Fed's capability to engineer a soft economic landing," said Samy Chaar, chief economist at Lombard Odier at Geneva.

Goldman Sachs expects the Fed will raise rates by 50 basis points at both its May and June meetings, following Powell's hawkish remarks.

Ten-year yields are also below three- and five-year yields - inverting part of the curve - on expectations that front-loaded hikes hurt growth.

John Higgins, chief market economist at Capital Economics, said some see the further drop in the two- and 10-year gap as a sign that the U.S.

economy will not be able to handle the monetary tightening that the market now discounts.

"After all, on four previous occasions since the late 1980s when this spread fell to, or below, zero, a recession ensued," Higgins said.

Two-year, five-year, 10-year and 30-year yields climbed further on Tuesday to their highest levels since 2019.

The moves have unsettled broader markets, hitting rate-sensitive sectors such as technology while driving the Japanese yen to a six-year low as higher yields draw investment from Japan.

The two-year U.S.

Treasury yield, which typically moves in step with interest rate expectations, was up 4.9 basis points at 2.183%.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) was last at 3.531%.

The 10-year TIPS breakeven rate was last at 2.95%, indicating the market sees inflation averaging about 3.0% a year for the next decade.

The U.S.
dollar five-years forward inflation-linked swap , seen by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's quantitative easing, PTS Terbaik ASEAN was last at 2.553%. (Reporting by Herbert Lash, additional reporting by Tom Westbrook and Saikat Chatterjee; editing by Jacqueline Wong, Barbara Lewis and Jonathan Oatis)