US economic growth may be the Fed’s Achilles' heel on its path to higher rates, market watcher says

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The Fed wants to hike rates, but this is their Achilles' heel

The Federal Reserve is all but guaranteed to raise interest rates in June, according to many investors and Wall Street economists.

Beyond that, the central bank's options are limited by one critical factor, according to one market watcher.

"While you have inflation and jobs numbers that are very Fed pleasing, you've got to watch out for that growth number which is expected to be somewhere" in the range of 3 percent, said Todd Colvin, senior vice president at Ambrosino Brothers, on CNBC's "Futures Now" this week.

After a disappointing start to the year, the U.S. economy's ability to reach 3 percent growth is still up for debate. Growth clocked in at 2.3 percent in the first quarter, up from 1.2 percent in the same period of 2017. Economists expect full-year economic growth of 2.7 percent, according to FactSet data.

"We need those tax cuts to feed through, something… we haven't really seen yet," said Colvin. "So, will we get 3 percent [growth]? That could be the Achilles' heel of the Fed raising rates higher or more than they currently want to," Colvin added.

The markets are pricing in the near-certainty of a 25-basis-point rate hike when the Federal Open Market Committee meets in June, according to CME Group fed funds futures. That would mark the second hike of the year. A third will likely come in September.

If the Fed hikes as markets expect, we could be on a path to yields far higher than current levels. Anything above a 3.25 percent yield on the 10-Year Treasury note would undermine the relative appeal of equities, says Colvin.

The 10-year yield hit a new high of 3.128 percent this week, a peak not seen since July 2011. The 30-year bond yield touched its highest level since October 2014.

"That could be the level where we see a sustained trade sideways, not only in [10-year debt], but I think you start to see some of that money leaving the stock market as opposed to just cash sitting on the sideline not entering the market," said Colvin.

Stocks have been in stasis for much of the year. The Dow Jones Industrial Average is flat for 2018, while the is up just 1.5 percent. The yield on the 10-year Treasury note, meanwhile, began the year at 2.41 percent and most recently traded north of 3.1 percent.

"The risk levels are just so night and day and mom-and-pop savers who have been punished over the last 10 years will look for the Treasury yields to give them what they've wanted all along and that's higher returns without the risk," he said.

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If yields get to this level, the bond market will turn into a major headwind for stocks