TREASURIES-U.S. 2-year yields surge on Fed rate hike prospects, curve flattens

* U.S. 2-year yield hits highest since Feb. 2020 * U.S. 5-year yield rises to highest since December 2019 * U.S. yield curve flattens * Fed funds futures price in nearly five hikes for 2022 * Fed funds price in 20% chance of 50 bps Fed hike in March (Adds new comment, result of U.S. 7-year auction, updates prices) By Gertrude Chavez-Dreyfuss NEW YORK, Jan 27 (Reuters) - U.S. yields on the shorter end of the curve soared on Thursday after Federal Reserve Chairman Jerome Powell flagged multiple interest rate increases this year, citing the economy's strong labor market and persistently high inflation. The surge in short-term yields and a corresponding decline in long-term rates flattened the yield curve, as traders braced for imminent rate hikes. The U.S. 2-year yield, which reflects interest rate expectations, surged to 1.208%, a nearly two-year peak. The U.S. 5-year yield, which is also an indicator of the market's rate outlook, climbed to 1.701% overnight, the highest since December 2019. But 5-year yields have since traded little changed at 1.6518%. Traders in the fed funds futures market moved to price in nearly five rate hikes this year in the wake of Powell's remarks on Wednesday, as the Fed held interest rates steady at its monetary policy meeting. Prior to the Fed meeting, rate futures showed about four rate increases for 2022. For the March meeting, fed funds futures have factored in about 30 basis points of tightening, while a 50-basis point hike implied a 20% probability. Powell on Wednesday said there is "quite a bit of room to raise interest rates without threatening the labor market that is by so many measures historically tight." "The Fed could hike four to five times this year and that's not horrendous because it is expected. What they decide to do this year is not all that important, except as to how it sets up for next year," said Jim Vogel, senior rates strategist, at FHN Financial in Memphis, Tennessee. "If the rate hikes this year are not enough and the Fed has to keep raising rates again in 2023 because everything they have seen in inflation from just six weeks ago makes them more nervous, that's a problem," he added. In afternoon trading, U.S. 2-year yields were last up nearly 8 basis points to 1.1683%, while 5-year yields were up 1 basis point at 1.6550%. A solid $53 billion U.S. 7-year note auction also added to bids on the longer end of the curve. The high yield was 1.769%, lower than the expected level at the bid deadline, suggesting strong demand. The bid-to-cover ratio, another measure of appetite for the debt, was 2.36, higher than the 2.28 average. Post-auction, U.S. 7-year note yields slipped 3 basis points to 1.7699. The benchmark 10-year yield slid 5 basis points to 1.8119%, while 30-year yields dropped 8 basis points to 2.1016%. The 2-year and 10-year yield curve flattened to 62.8 basis points, the narrowest since late November. Another yield curve measure, the spread between 5-year and 30-year yields declined as well, to 42.4 basis points , the flattest in two weeks. January 27 Thursday 2:45PM New York/1945 GMT Price Current Net Yield % Change (bps) Three-month bills 0.205 0.208 0.008 Six-month bills 0.4225 0.4293 0.038 Two-year note 99-102/256 1.1803 0.089 Three-year note 99-48/256 1.4058 0.065 Five-year note 99-70/256 1.6518 0.007 Seven-year note 97-104/256 1.7748 -0.025 10-year note 96-44/256 1.803 -0.043 20-year bond 97-88/256 2.1656 -0.065 30-year bond 95-88/256 2.0856 -0.080 DOLLAR SWAP SPREADS Last (bps) Net Change (bps) U.S. 2-year dollar swap 13.75 0.25 spread U.S. 3-year dollar swap 13.75 -0.25 spread U.S. 5-year dollar swap 6.00 -0.75 spread U.S. 10-year dollar swap 6.00 0.00 spread U.S. 30-year dollar swap -17.00 1.25 spread (Reporting by Gertrude Chavez; Additional reporting by Yoruk Bahceli in Amsterdam and and Kevin Buckland in Tokro; Editing by Catherine Evans and Nick Zieminski)