American workers are finally starting to see an increase in their wages, but that may stoke inflation concerns and pressure the markets, said James Paulsen, chief investment strategist at Wells Capital Management.
"Eighty percent of the nonsupervisory wage earners have seen their wage inflation accelerating now for more than a year," he said on CNBC's "Squawk Box" on Thursday. "If wage inflation goes up 3 percent that's not all bad. But for investors worried about interest rate pressures, it is bad."
"The real driver of Fed policy," Paulsen said, "is the bond vigilante taking the 10 year [Treasury yield] towards 4 percent. Once it gets toward that level, the Fed's decision is made for it. They'll have to start tightening."
Right now though, good news on the economy is good news for the markets, he said—reiterating his prediction that stocks should continue higher before pulling back later in the year.
"I'm already seeing some evidence where good news could become bad news," he said—painting a scenario where a "panic about inflation" could feed into bonds. The 10-year Treasury yield could top 3.5 percent before year-end, he added. "That's where maybe we get a little bit of [a stock] correction. But I think it comes from 2,000 [for the S&P 500] back to where we started the year, as opposed from here to lower."
The S&P bounced back Wednesday, finishing at 1,888—just a half percent away from its closing high.
Paulsen said he'd view any pullback as a buying opportunity. "I still there's a lot to like over the next several years ... in the stock market. We've just got to get used to this Fed going full-bore ease to full-bore tightening."
While the interest rate question is still up in the air, the Fed has already started to scale back its other weapon designed to support the economy. So far, policymakers have tapered central bank bond purchases in four $10 billion moves to a pace of $45 billion a month.