TREASURIES-U.S. 2-year yield hits highest in nearly two years on hawkish Powell

* Powell flags rate hike in March * Fed to end asset buying in early March * U.S. rate futures price in four hikes after Fed statement (Recasts, adds new comment, Fed's Powell comments, updates prices) By Gertrude Chavez-Dreyfuss NEW YORK, Jan 26 (Reuters) - U.S. Treasury 2-year yields surged to their highest since February 2020 after Federal Reserve Chair Jerome Powell struck a hawkish tone, flagging an interest rate increase in March and saying there is room for further policy tightening without hurting employment. U.S. 2-year yields, which reflect interest rate expectations, soared to a nearly two-year peak of 1.0950% and were last up nearly 6 basis points at 1.0849%. U.S. 5-year, 10-year, and 30-year yields all rose to one-week highs. Powell, in his news briefing after the Federal Open Market Committee (FOMC) held rates steady, said the committee is "of a mind" to raise rates in March. "When reporters asked Powell if the Fed would consider raising rates at every meeting (more than four times this year) he didn't say they wouldn't, which indicates a flexibility to raise rates much more quickly, if necessary, than anyone was expecting," said Chris Zacarelli, chief investment officer at Independent Advisor Alliance in Charlotte, North Carolina. Fed funds futures have fully priced in a quarter-point tightening for the Fed's March meeting, and another three hikes for 2022. "With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate," the U.S. central bank's rate-setting Federal Open Market Committee said in a policy statement. Market participants said Powell was more hawkish than the FOMC statement. The Fed also gave some guidance on shrinking its nearly $9 trillion balance sheet. The bank said it expects to begin reducing the Fed's balance sheet after they start raising interest rates, according to principles released by the Fed on Wednesday. "The Fed is showing it will be flexible with the balance sheet, but eventually they will have to choose between fighting inflation or avoiding a deterioration in financial conditions," said Edward Moya, senior market analyst, The Americas, at OANDA. In late afternoon trading, the benchmark U.S. 10-year yield rose 6 basis points to 1.8476%. U.S. 30-year yields were up 3 basis points at 2.1612% . On the front end of the curve, U.S. 5-year yields, which also reflects the market's interest rate outlook, was up 10 basis points at 1.6648%. The U.S. yield curve flattened some more following the comments, as investors braced for looming rate hikes that push short-term rates higher. The gap between 2-year and 10-year yields fell to 69.8 basis points, the narrowest since late November. January 26 Wednesday 3:55PM New York / 2055 GMT Price Current Net Yield % Change (bps) Three-month bills 0.2 0.2029 0.010 Six-month bills 0.4 0.4064 0.017 Two-year note 99-124/256 1.1365 0.110 Three-year note 99-66/256 1.3811 0.105 Five-year note 99-56/256 1.6631 0.096 Seven-year note 97-46/256 1.8101 0.079 10-year note 95-200/256 1.8476 0.063 20-year bond 96-80/256 2.2313 0.042 30-year bond 93-176/256 2.1635 0.033 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 13.50 0.00 spread U.S. 3-year dollar swap 13.50 -0.25 spread U.S. 5-year dollar swap 6.75 -0.25 spread U.S. 10-year dollar swap 6.00 0.25 spread U.S. 30-year dollar swap -18.50 0.00 spread (Reporting by Gertrude Chavez-Dreyfuss; Additional reporting by Sinead Carew; Editing by Will Dunham, Chizu Nomiyama and Jonathan Oatis)