Could inflation be the new subprime?

An important point to remember about inflation

When Fed Chair Janet Yellen essentially dismissed inflation as a threat last week, she sought to calm investors' fears but in doing so also raised an unpleasant specter of the not-too-distant past.

To some, the central bank chief's assertion that inflation threats were coming from "noisy" data—economist talk for volatile, one-off conditions not likely to persist—sounded at least a little like her predecessor, Ben Bernanke, who in March 2007 said problems in the subprime mortgage market were "contained" and unlikely to pose a larger, more systemic threat. The subprime market, of course, was in the early stages of a meltdown that spread across the financial system and triggered the worst economic downturn since the Great Depression.

"Do not be surprised if 'noisy' is now the new 'transitory,'" Tom Porcelli, chief U.S. economist at RBC Capital Markets, said in a note to clients.

"This is part of a larger message that came through in Yellen's press conference. That is that the Fed is not setting policy based on their best guess of where they believe the economy will be, but rather where the economy has been," he added. "In other words, instead of trying to shape the economy on a forward-looking basis through monetary policy, they are instead more likely to react to largely coincident-to-lagging developments. The potential for a policy mistake and a Fed that falls well behind the curve seems obvious."

For Porcelli and other Wall Street pros who issued warnings on Yellen's blithe inflation comments, the worry is that the Fed waits too long to give at least lip service to an inflation threat and ends up having its hand forced in tightening monetary policy and raising interest rates.