Is a 'panic taper' the real risk to markets?

These indicators could lead to panic taper: Pro

Markets have been obsessed with the timing of the dreaded 'taper' for most of 2013, but according to Wells Capital's Jim Paulsen, the real focus shouldn't be on timing, but on whether the Fed will conduct a controlled taper or a 'panic taper.'

All eyes are on the Federal Open Market Committee meeting on Wednesday and an increasing number of analysts are expecting them to act this week. But Paulsen, who is chief investment strategist of the $350 billion investment firm, told CNBC that the market's obsession with timing was misguided.

"I think tapering will start on Wednesday…. [But] I don't think [tapering] is as big an event as we make it out to be, whether they do it now, or in January, or in March, I think the markets well anticipate there is going to tapering here pretty soon," Paulsen told CNBC.

(Read more: Why the Fed won't taper in December: Goldman Sachs)

"The real issue is not when they will start to taper, it's whether the taper be voluntary by the Fed and controlled on their timetable, or whether it be accelerated and forced upon the Fed as the year moves along and the economic data becomes too strong or inflation raises its head," he said.

According to Paulsen one of the bigger risks for U.S. central bankers would be if money velocity – which is the rate at which money is exchanged from one transaction to another – speeds up more quickly than expected, forcing the Fed to accelerate the process of tapering.

Mario Tama | Getty Images News

"If velocity rises, the Fed won't be able to drain quantitative easing reserves fast enough to calm anxieties of potential overheated/inflationary consequences from the past few years QE program," he said.

"Typically, Fed policy shifts gears only under panic conditions and this is my best guess as to how Fed policy will most likely be reversed in 2014," he added.

The Fed has reiterated several times that it will only start cutting back its $85 billion a month asset purchase program once it was confident enough that the economy could withstand it. It set thresholds including an unemployment rate at 6.5 percent and has also said inflation would need to increase to 2.5 percent. Currently the unemployment rate sits at 7 percent and inflation remains well below target.

(Read more: Gold is just the tip of the 'Taper Tantrum')

But Paulsen said the Fed might be forced to accelerate the taper if inflation fear, as opposed to actual inflation, starts to take hold.

"It's not critical that we have a real inflation problem. It's just a matter of whether we have an inflation fear and I can see the ingredients of that. That to me is the bigger event that could occur sometime in 2014," he added.

No taper this week: Gartman

Triggers for 'inflation fear,' according to Paulsen, include the falling unemployment rate, a new Fed chairman who is widely perceived to be dovish and rising industrial commodity prices, for example.

"If wage inflation were to tick up a little we just could have a panic about it," he added.

Paulsen added that the size of the taper, another debate which has dominated market discussions in recent weeks, would likely be on the smaller side.

(Read more: Fed's dreaded 'taper' may not hurt after all)

Analysts expect the Fed to taper by an amount ranging from $25 billion to $5 billion.

"I think if they do do it, it's just going to be a baby step. They'll do it just to put in motion before Yellen takes the helm and to mark the end of Bernanke's helm," he added.

The chief investment strategist also told CNBC he expected the S&P 500 to continue to run higher next year towards the 2,000 level as optimism on the U.S. economy improves.

However, he said it would see a 10 percent correction once panic sets in over whether the Fed can reverse policy fast enough to combat a pick up in money velocity.

The closed at 1,786.54 on Monday.

By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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