Inflation has been so dead for so long that traders barely pay attention anymore. But when the latest numbers showed December CPI creeping up 0.3% to a six-month high, one has to wonder if this long-dormant beast is starting to snap back to life.
Certainly many pundits have incorrectly predicted that a tidal wave of inflation would arrive as the result of the Fed’s unprecedented interventionism (aka QE), but as Wells Capital’s chief strategist Jim Paulsen explains in the attached video, the fear of inflation will be dangerous long before the real thing hits. It’s all part of what he calls “a cocktail of overheated fear.”
“In the last five or six years we’ve been worried about nothing but deflation and weak growth,” Paulsen says, “so it’s very difficult to imagine that we might get to a point where we’re worried about an overheated economy again, but I think we’ve got a shot at that (this year).”
As Paulsen tells it, we clearly don’t have a serious inflation problem yet, but he thinks we could soon have a serious fear of inflation problem, before singling out a number of different things, or ingredients, that could all come together and make it happen.
Among the issues he thinks could collude to stoke concerns that a stodgy economy is running too hot include the debut of a brand new (and dovish) Fed chairman who takes the helm at a time when the dollar is weak, and a 6.7% unemployment rate has fostered the tightest labor market we’ve seen since the start of the recovery.
That alone, it could be argued, might be enough to stoke things but Paulsen pours even more gas on the fire (or booze in the blender) by noting that the factory utilization rate is about to breach 80%, raw materials and commodities “are up significantly since October” at a time when all parts of the world are growing, and contributing to what he calls “a synchronized recovery.”
“If you put all those together I think that could cause people to worry about overheating or inflation,” he says, conceding that we will still need to see a string of stronger numbers down the road.
As far as protecting yourself, and your portfolio, Paulsen says investors should closely watch three things for signs of overheating: if core CPI gets above 2%, if wage growth goes from 2% to around 2.5%, and if the 10-year Treasury yield (^TNX) approaches 3.5%.
As Paulsen summarizes in a recent note, “I do not expect a real inflation problem this year, just a mild pickup in inflation and a mini-inflation panic.”
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