Federal Reserve Chairman Jerome Powell testified before a U.S. Senate panel that the central bank's monetary-policy committee will keep the economy from overheating, adding to speculation over rising interest rates that have rattled markets this week.
Powell said Thursday the Federal Open Market Committee, which has raised interest rates five times since late 2015, will "strike a balance between avoiding an overheated economy" and allowing inflation to rise.
While high inflation is considered bad for the economy, the Fed has been troubled by persistently low inflation in recent years. When inflation is low, it's usually seen as a sign of a sluggish economy. The Fed's preferred measure of inflation climbed 1.7% last year, below the central bank's target of 2%.
Powell told the Senate Banking Committee that while there's "no evidence that the economy is overheating," he expects unemployment at a 17-year low to lead to accelerating wage increases that in turn might drive up inflation.
The Fed chair was testifying before Congress as part of its semi-annual report on monetary policy.
His comments before the House of Representatives on Tuesday have strengthened convictions that the Fed will continue on its pace of gradual rate increases, with many traders now speculating that four hikes may be in the offing this year, instead of the three projected in the central bank's latest forecast.
The Standard & Poor's 500 Index fell 1.7% Thursday and was down 2.9% on the week.
Yields on 10-year U.S. Treasury notes fell by 0.06 percentage point, a sign that traders saw an increasing likelihood that the Powell-led Fed would stick with its promise to raise rates enough to keep inflation from climbing too quickly.
Over the past few months, investors have kept a close eye on surging Treasury yields, often seen as a barometer of future inflation. Yields on the 10-year note have climbed to 2.81% from 2.43% at the end of the year, due to the prospect of higher inflation as well as increased Treasury-bond sales to cover the cost of the recently enacted tax cuts.
Lindsey Bell, an investment strategist at the analysis firm CFRA Research in New York, wrote in a report Thursday that the yields have risen "far too fast for the market to digest."
"A real tug of war is developing between higher economic growth, improved corporate earnings and global growth on one hand, and the potential for increases in inflation, rising interest rates and an increased national deficit on the other," Bell wrote. "Higher interest rates and higher levels of inflation are normal in an improving economy, but the speed at which those rates increase needs to be steady and not swift."
Last month, the Wall Street firm Goldman Sachs Group Inc. (GS - Get Report) lifted its forecast for year-end 10-year yields to 3.25% from 3%, adding that they could eventually reach 3.75% during the current economic expansion.
According to Goldman Sachs, additional moves higher in the yield might reflect wariness by investors of holding bonds that don't pay off for a decade -- since their value typically falls harder than shorter-term securities when interest rates rise.
"We find that U.S. term premium should increase as the economy progressively overheats," the Goldman analysts wrote in the Feb. 16 report.
Goldman Sachs economists wrote in a separate report last week that a rise in yields to 4.5% could trigger a 20% to 25% decline in prices for stocks.