Hedge fund star Kyle Bass sees 'stagflation' coming in 2017

Kyle Bass
Mary Catherine Wellons | CNBC
Kyle Bass

The U.S. economy is moving into a period of higher inflation but still-tepid growth, posing a difficult investing environment, famed short-seller Kyle Bass said Wednesday.

Bass, who made his name betting against subprime mortgages ahead of the 2008 financial crisis, warned that the combination will create an environment of "stagflation," a term that came into widespread use during the 1970s when both consumer prices and unemployment were on the rise.

"You have wages up, you have real estate rent moving up, now you have commodities bouncing. So 2017 is going to be a year of increasing inflation but economic growth lagging," Bass said during an interview on CNBC's "Power Lunch." "We're moving into a stagflationary environment in my view."

From an investment standpoint, the Hayman Capital Management founder and CIO said the main advice is for investors to stay away from long-duration bonds. Inflation usually causes bond yields to rise and prices to fall, creating capital losses for investors.

To be sure, recent years have seen repeated calls for investors to avoid fixed income at the far end of the curve. However, the iShares 20+ Year Treasury Bond exchange-traded fund has had a stellar year, turning in a price gain of 10.2 percent as of afternoon Wednesday.

Economic growth indeed has been slow. Gross domestic product averaged just 1.1 percent growth in the first half of the year. Third-quarter growth is expected to be a bit better. Economists surveyed by Reuters put Q3 GDP at 2.6 percent, though the Atlanta Fed's forecast is for just 2 percent expansion, a number that had been as high as 3.8 percent.

Wages have nudged higher, with average hourly earnings up 2.6 percent on an annualized pace in September. The consumer price index, excluding food and energy, rose at a 2.2 percent pace in September.

Bass said he has few equity holdings, so he had no recommendations on the stock market. However, he said his economic call shouldn't be interpreted as a doomsday prediction for Wall Street.

"I'm not saying the market's going to crash," Bass said. "I'm just saying it's going to have a real hard time generating positive real returns in the next few years."