Futures Now

A fire sale by the Treasury could send shock waves through the bond market, strategist warns

This area of the bond market is concerning Wells Fargo the most
This area of the bond market is concerning Wells Fargo the most

Wells Fargo's head of interest rate strategy is detecting a major trouble spot in the bond market.

Michael Schumacher's chief concern right now: Who's going to buy all those extra Treasury notes?

"They [people] are worried about Treasury issuance going up, up, up. You could see an increase in 2018 of 50 percent — maybe more versus last year. That's got a lot of people very concerned, myself included," he said recently on CNBC's "Futures Now."

He anticipates the Treasury Department will likely announce within days a "pretty significant change" in the way it issues bonds. It comes just as the Fed is shrinking its balance sheet. With less demand coming from the Fed, a fire sale of sorts would increase supply and emerge as the major catalyst causing yields to jump.

"You could see a pretty significant sell-off not just in the 10-year, which people focus on quite a bit, but also on 30-year bonds. We're very concerned about that," Schumacher said. "Being the bond nerd that I am, I'd say the market wants to climb a wall of worry like it does in stocks."

Right now, 10-year Treasury yields are bouncing around 2.6 percent — up nearly 40 basis points during the past six months. Schumacher's year-end forecast on the note is 2.95 percent. But he believes it's not unreasonable to expect rates to push 3.25 percent.

"Something around that level probably does get people pretty worked up. And, it's such a contrast versus last year when bonds did very, very little," he said.

Yields for 30-year Treasurys, essentially flat for the past six months, appear to be waking up. They're up about 17 basis points this year.

"We're actually very concerned about the very long end of the curve. So, you think about the 30-year bond," said Schumacher. "The reason for this is that typically when the U.S. runs a much worse budget deficit, which we think is pretty likely for this year."

His latest forecast comes just days before Janet Yellen begins her final two-day Federal Reserve meeting as chair this week. Her term ends Saturday. Jerome Powell, who's expected to resume Yellen's interest rate hike policy, will be replace her.

"People have also become more concerned about the Fed. If you look at what the market is pricing in in terms of Fed rate hikes this year, that's gone up a bit. Now it's probably [an average of] 2.6 or 2.7 hikes" this year, Schumacher said. "I give risk on a little bit more weight."