Inflation breakout will drive 10-year Treasury yields above 2% in coming months, Wells Fargo predicts

Treasury yields may be about to break out.

Even though yields temporarily fell after this week's Federal Reserve decision on interest rates, Wells Fargo Securities' Michael Schumacher expects the benchmark 10-year Treasury Note rate to end the year as high as 2.20%.

"The 10-year yield is going up a fair bit through the remainder of the year," the firm's head of macro strategy told CNBC's "Trading Nation" on Thursday. "Not a steady rise to be sure. But we do think there's a pretty strong bear case to be made over the next six [to] seven months."

Schumacher attributes the inflation comeback for his forecast — with an emphasis on the next 12 months.

"Core PCE which the Fed likes to look at is above 3% for the next year. It's an amazing number. We have not seen inflation like that in the U.S. on a sustained basis for a very long time," he said. "This really gets at what the people in the market are focused on: Just how long is that inflation spike going to last? Is it transient? Is it transitory? I don't know. But it's troubling, that's pretty clear."

In his post-Fed decision research note, Schumacher said the Fed is still coming to terms with the inflation spike. According to Schumacher, the biggest risk facing the bond market and economy is the Fed's potential response to the strong economic comeback. If the Fed gets spooked, it would likely hike rates next year instead of waiting until at least 2023.

So far, Schumacher's bond market outlook is on target.

Coming into 2021, Schumacher predicted the 10-year yield would hit 1.15% to 1.35% by this year's halfway point — with the caveat it could reach as high as 1.50%. He made the forecast when the yield was below 1% and months before the Covid-19 vaccines were widely available.

On Thursday, the 10-year yield closed at 1.51%. It's up almost 4% over the past week, but down 8% over the past three months.

He also doubts the dollar, which initially surged on a more hawkish Fed, will continue to extend its gains.

"For the first quarter of this year, the U.S. and arguably the U.K. had a tremendous advantage over most of the Western world in terms of Covid vaccinations. Now, a lot of countries are catching up, and you could view that as a proxy for future economic activity," Schumacher said. "The dollar is losing some of those tailwinds."

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